Suppose Eastern Bank offers Gulf Refinery a \(\$ 150\) million floating-rate loan along with a cap to finance the purchase of its drilling equipment. The floating-rate loan has a maturity of two years, starts on December 20, and is reset the next seven quarters. The initial quarterly rate is equal to \(2.5 \% / 4\) and the other rates are reset quarterly to equal to one fourth of the annual LIBOR on those dates plus 150 basis points: (LIBOR \% +1.5\%)/4. The cap Eastern Bank is offering Gulf has the following terms:

- Seven caplets with expiration dates of 3/20, 6/20, and 9/20.

- The cap rate on each caplet is \(2.5 \%\).

- The time period for each caplet is 0.25 per year.

- The payoffs for each caplet are at the interest payment dates of the loan.

- The reference rate is the LIBOR.
- Notional principal is \(\$ 150\) million.
- The cost of the cap is \(\$ 300,000\).

TABLE 8.2

Complete Table 8.3, showing the company’s quarterly interest payments, caplet cash flows, hedged interest payments (interest minus caplet cash flow), and hedged and unhedged rate as a proportionof a \($150\) million loan (do not include cap cost) for each period, given LIBOR rates starting at 1% on3/1/Y1 and then increasing each period by 50 bp.

Table 8.3.

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T 3/20/T1 6/20/T1 9/20/T1 12/20/T1 3/20/T2 6/20/T2 X Co 4 $993,750 $993,750 $993,750 4.2 $993,750 $993,750 $993,750 9/20/T2 $993,750 4.4 4.6 4.8 5 5.2 Cost Total Cost of 10 = Calls: $80,500 Date LIBOR % Futures Call Cash and Spot Price ST Flow at Option's fr Value of Call Cash Flow at Receipt Date Expiration (Call CF at T) Quarterly Hedged Hedged Unhedged Interest Interest Rate [(4) Rate at Receipt Revenue Date 0.25 Col 6+ Col (Col LIBOR + 7)]/$10m 100bp 10(Max[fr (1+LIBOR)-25 [(LIBOR 5 + 0.01)] $993,750, ($10m) 0] 12/20 1.50 3/20 1.50 $996,250 $25,000 $62,500 $62,500.00 0.025 0.025 6/20 2.00 $995,000 $12,500 $25,093.23 $62,500 $87,593.23 0.035 0.025 9/20 2.50 12/20 3.00 3/20 3.50 6/20 4.00 9/20 4.50 12/20