Question

ework o Savea Help Save & Exit Submit Check my work An Fl has purchased a $220 million cap of 8 percent at a premium of 0.55 percent of face value. A $220 million floor of 6.0 percent is also available at a premium of .60 percent of face value. a. If interest rates rise to 9 percent, what is the amount received by the FI? What are the net savings after deducting the premium? b. If the Fl also purchases a floor, what are the net savings if interest rates rise to 10 percent? What are the net savings if interest rates fall to 5.0 percent? (Negative amounts should be indicated by a minus sign.) c. If, instead, the Fl sells (writes) the floor, what are the net savings if interest rates rise to 10 percent? What if they fall to 5.0 percent? (Negative amounts should be indicated by a minus sign.) a. Amount received Net savings b. Net savings if interest rates rise to 10 percent Net savings if interest rates fall to 5 percent c. Net savings if interest rates rise to 10 percent Net savings if they fall to 5 percent ercent < Prev 5 of 5 Next

This is all the information given

Answer 1

Solution :-

(a) Amount Received = $220 million

Amount recevied when the cap is breached = (9% - 8%) * 220 million = 2200000

Premium paid for the cap = 220 million * 0.55% = 1210000

Net savings = $990000

(b) Cost of Floor = 220 million * 0.60% = 1320000

Total cost of hedge = Cost of Cap + Cost of Floor = 1210000 + 1320000 = 2530000

If rates increase to 10%, the amount recd. = 220 million * (10% - 8% ) = $4400000 = $4.4 million

Net savings = 4400000 - 2530000 = $1870000 = $1.87 million

If rates decline to 5 %, the amount recd. = 220 million * (6% - 5%) = 2200000 = $2.2 million

Net savings (loss) = (2200000 - 2530000) = - $330000 = - $0.33 million

(c) : Premium recd. for writing the floor = $1320000

Premium Paid for Cap Floor = $1210000

Net Cost = - 1210000 + 1320000 = 110000 ( Since Paid is less then received )

If rates increase to 10%, the amount recd. = 220 million * (10% - 8% ) = $4400000 = $4.4 million

Net Savings = 4400000 + 110000 = $4510000 = $4.51 million

Net savings (loss) when rates decline to 5% then amount paid = 220 million * (6% - 5%) = 2200000 = $2.2 million

- 2200000 + 110000 = - $2090000 = - $2.09 million

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