Suppose that a savings and loan association buys an interest-rate cap that has these terms: The reference rate is the six-month Treasury bill rate; the cap will last for five years; payment is semiannual; the strike rate is 5.5%; and the notional principal is $10 million. Suppose further that at the end of a six-month period, the six-month Treasury bill rate is 6.1%.

a. What is the amount of the payment that the savings and loan association will receive?

b. What would the writer of this cap pay if the six-month Treasury rate were 5.45% instead of 6.1%?

AppendixLO1