Suppose Star Bank sells XU Trust a two-year $15 million FRN paying the LIBOR plus 150 basis points. The note starts on 3/20 at 9% and is then reset the next seven quarters on dates 6/20, 9/20, and 12/20. Suppose a money center bank offers Star Bank a cap for $200,000, with the following terms corresponding to its floating-rate liability:

• The cap consists of seven caplets coinciding with the reset dates on the note
• Exercise rate on the caplets = 7%
• Notional principal = $15 million
• Reference Rate = LIBOR
• Time period on the payoffs is .25
• Payoff is paid on the payment date on the note
• Cost of the cap is $200,000 and is paid on 3/20

1. Show in a table Star Bank’s quarterly interest payments, caplet cash flows, hedged interest cost (interest minus caplet cash flow), and hedged rate as a proportion of the $15 million FRN loan (do not include cap cost) for each period given the following rates: LIBOR = 7.5% on 3/20, 8% on 6/20, 9% on 9/20, 8% on 12/20, 7% on 3/20, 6.5% on 6/20, 6% on 9/20, and 5.5% on 12/20.

2. To help defray part of the cost of the cap, suppose Star Bank decides to set up a collar by selling a floor to one of its customers with a floor rate of 6.5% for $150,000 with the following terms:

• The floor consists of seven floorlets coinciding with the reset dates on the note
• Exercise rate on the floorlets = 6.5%
• Notional principal = $15M
• Reference Rate = LIBOR
• Time period on the payoffs is .25
• Payoff is paid on the payment date on the note
• Cost of the floor is $150,000 and is paid on 3/20

Evaluate Star Bank’s hedged interest costs using the collar.

Answer rating: 100% (QA)

Period Interest Payment Caplet Cash Flow Hedged Interest Cost Hedged Rate 320 225000 0 ... View the full answer