Please Solve It

Final 1226 views 3 replies

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!

Replies (3)

Dear forget this formula... Try it.

In the given question, we have been given lumpsum premium of 1%. 

The objective is the convert this lumpsum amount in equalised half yearly payments.

Lumpsum Premium = 20 million * 1% = 2 Lakhs

Now fixed rate of interest = 6% annaully = 3% half yearly.

Period = 2 years = 4 half years

Annuity factor @ 3% for 4 periods = 3.717

Hence, equalised payments = 200000/3.717 = 53806..

Difference is due to rounding off by institute in the material.. check it.

Thanks...thank you so much, how silly i am

Your answer wrong, we have to discount from 2nd period to 4th  period not from 1st period, First 3 month borrowing rate is decided at 0th day which is current spot interest rate. No one hedges at spot rate. Annuity factor @ 3% from 2nd to 4th is 2.7462


CCI Pro

Leave a Reply

Your are not logged in . Please login to post replies

Click here to Login / Register