The Acme Insurance Company purchased a five-year bond whose interest rate floats with LIBOR. Specifically, the...

Transcribed Image Text:

The Acme Insurance Company purchased a five-year bond whose interest rate floats with LIBOR. Specifically, the interest rate in a given year is equal to LIBOR plus 200 basis points. At the same time that the insurance company purchases this bond, it enters into a floor agreement with J.P. Morgan in which the notional principal amount is $35 million with a strike of 6%. The premium Acme Insurance Company agrees to pay J.P. Morgan each year is $300,000. Suppose at the time that it is necessary to determine whether a payment must be made by J.P Morgan, the LIBOR is 9%. How much must Bear Stearns pay Acme Insurance Company? The Acme Insurance Company purchased a five-year bond whose interest rate floats with LIBOR. Specifically, the interest rate in a given year is equal to LIBOR plus 200 basis points. At the same time that the insurance company purchases this bond, it enters into a floor agreement with J.P. Morgan in which the notional principal amount is $35 million with a strike of 6%. The premium Acme Insurance Company agrees to pay J.P. Morgan each year is $300,000. Suppose at the time that it is necessary to determine whether a payment must be made by J.P Morgan, the LIBOR is 9%. How much must Bear Stearns pay Acme Insurance Company?

Answer rating: 100% (QA)

To solve this problem we need to determine whether the interest rate on the bond is below the floor ... View the full answer