Question
XYZ Plc. borrows 20 Million Pounds of 6 months LIBOR+0.25% for a period of two years.
Mr. David, Treasury Manager of XYZ anticipates a rise in LIBOR, hence proposed to buy a Cap Option from a ABC Bank at strike rate of 7%.
The lump sum premium is 1% for the whole of the three resets period and the fixed rate of interest is 6% p.a. The actual position of LIBOR during the month coming reset period is as follows:
Reset Period LIBOR
1 8.00%
2 8.50%
3 9.00%
This is question of May 2011 RTP Final New Course.
I am not able to understand the "Calculation of Premium Payable to bank " which is computed in the solution as follows :
0.01
= ------------------------------------------- x 20,000,000
1
(1/0.03) - ---------------------
0.03 x (1.03)4 ( i.e. 1.03 have its power 4)
Please interpret it.
Thanks in Advance!
CAclubindia
