a. If you are certain that interest rates will rise, should you consider purchasing a callable swap
Question:
a. If you are certain that interest rates will rise, should you consider purchasing a callable swap instead of the collar? Explain.
b. Explain the conditions under which your purchase of an interest rate collar could have unintended consequences.
Suppose you are a manager of a financial institution. You recently purchased a three-year interest rate collar with LIBOR as the interest rate index. The interest rate cap specifies a fee of 2 percent of $60 million notional principal and an interest rate ceiling of 9 percent. The interest rate floor specifies a fee of 3 percent of the $60 million notional principal and an interest rate floor of 7 percent. Assume that LIBOR is expected to be 6 percent, 10 percent, and 12 percent (respectively) at the end of each of the next three years.
Financial Institutions Management A Risk Management Approach
ISBN: 978-0071051590
8th edition
Authors: Marcia Cornett, Patricia McGraw, Anthony Saunders