Question

4. Assume that the formula for the coupon rates of a floater and an inverse floater are: Floater coupon rate: reference rate + 2.15% Inverse floater coupon rate: 12.5% - reference rate Suppose the $100 million of the bond is used as collateral to create a floater with par value of $50 million and an inverse floater with a par value of $50 million, answer the following questions: (3 points)

(1) What is the coupon rate of the fixed rate collateral for these two floating rate bonds?

(2) Suppose the floor for the inverse floater is 1.25%. What would be the cap of the floater?

Answer 1

21) 3 4 5 Floater coupon rate + Inverse coupon rate = Fixed coupon rate Fixed coupon rate = reference rate + 2.15% +12.5% - reference rate Fixed coupon rate = 14.65% Floor for inverse floater = 1.25% Inverse floater coupon rate= 12.5% - reference rate 1.25%=12.5%-reference rate Reference rate = 12.5%-1.25% = 11.25% Floater coupon rate: reference rate + 2.15% Putting in the value of reference rate Floater coupon rate=11.25%+2.15% = 13.4% cap of the floater= 13.4%