Sam Baxter is a derivative analyst for Rock Asset management. One of Sam's clients plans initial an merger & acquisition in 120 days. This acquisition will be financed by a $ 10,000,000 loan with a term of 180days and rate is 180-day Libor plus 350 bps. Principal and interest will be paid in arrears (at the end of each loan period). Sam's client worries about a potential increase on interest rate 120 days later before he initials a loan for acquisition.

Sam suggests his client to buy an interest rate call option on 180-day Libor with an exercise rate of 2.4% for a premium of $75,000. This interest call option expires in 120 days and any payoffs from this call option occurs at the end of loan period. Current 180-day Libor is 2.5%. The client can finance the call option premium at current 180-day Libor plus 350 bps.

120 days later, the 180-day Libor is 3.8% when the loan is initiated. Calculate the effective annual rate on the loan.

Answer rating: 100% (QA)

To calculate the effective annual rate on the loan we need to calculate the total cost of the loan i... View the full answer