The Acme Insurance Company purchased a 5-year bond whose interest rate floats with LIBOR. Specifically, the interest rate in a given year is equal to LIBOR plus 200 basis points. At the same time the insurance company purchases this bond, it enters into a floor agreement with the Bear Stearns in which the notional amount is Ҏ35 million with a strike price of 6%. The premium Acme Insurance Company agrees to pay Bear Stearns each year is Ҏ300,000. a) Suppose at the time that it is necessary to determine whether a payment must be made by Bear Stearns, LIBOR is 9%. How much must Bear Stearns pay to Acme Insurance Company? b) Suppose at the time that it is necessary to determine whether a payment must be made by Bear Stearns, LIBOR is 3%. How much Bear Stearns pay to Acme Insurance Company?
The Acme Insurance Company purchased a 5-year bond whose interest
rate floats with LIBOR. Specifically, the interest rate in a given year is
equal to LIBOR plus 200 basis points. At the same time the insurance
company purchases this bond, it enters into a floor agreement with the
Bear Stearns in which the notional amount is Ҏ35 million with a strike
price of 6%. The premium Acme Insurance Company agrees to pay Bear
Stearns each year is Ҏ300,000.
a) Suppose at the time that it is necessary to determine
whether a payment must be made by Bear Stearns, LIBOR
is 9%. How much must Bear Stearns pay to Acme Insurance
Company?
b) Suppose at the time that it is necessary to determine
whether a payment must be made by Bear Stearns, LIBOR
is 3%. How much Bear Stearns pay to Acme Insurance
Company?
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