Harold intends to borrow $10 million for 12 months, in three months time. He is able to borrow with quarterly interest payments and resets at BBSW +0.5% p.a., but fears that rising interest rates will increase his borrowing costs. A 12-month interest rate cap with a strike rate of 6.5% p.a. and referenced to BBSW commencing in three months, is available for the premium of 0.15% p.a. Determine the amount, direction and timing of the payments that will be made under the combination of the loan and cap if the BBSW in 3, 6, 9 and 12 months is respectively 5.9%, 6.4%, 7.2% and 8.0% p.a. (Assume 90 day quarters and a 360 day year.)

Answer rating: 100% (QA)

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