Question: Suppose a bank enters into an agreement to make a
Suppose a bank enters into an agreement to make a $10 million, three-year floating-rate loan to one of its best corporate customers at an initial rate of 8 percent. The bank and its customer agree to a cap and a floor arrangement in which the customer reimburses the bank if the floating loan rate drops below 6 percent and the bank reimburses the customer if the floating loan rate rises above 10 percent. Suppose that at the beginning of the loan's second year, the floating loan rate drops to 5 percent for a year and then, at the beginning of the third year, the loan rate increases to 12 percent for the year. What rebates must each party to the agreement pay?
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