Question: Northbrook Bank purchases a four-year cap for a fee of 3 percent of notional principal valued at $100 million, with an interest rate ceiling of

Northbrook Bank purchases a four-year cap for a fee of 3 percent of notional principal valued at $100 million, with an interest rate ceiling of 9 percent, and LIBOR as the index representing the market interest rate. Assume that LIBOR is expected to be 8 percent, 10 percent, 12 percent, and 13 percent, respectively, at the end of each of the next four years.

a. Determine the initial fee paid, and also determine the expected payments to be received by Northbrook if LIBOR moves as forecasted.

b. Determine the dollar amount to be received (or paid) by the seller of the interest rate cap based on the assumed forecasts of LIBOR.

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