An FI has purchased a $200 million cap of 9 percent at a premium of 0.65 percent of face value. A $200 million floor of 4 percent is also available at a premium of 0.69 percent of face value.

a. If interest rates rise to 10 percent, what is the amount received by the FI? What are the net savings after deducting the premium?

b. If the FI also purchases a floor, what are the net savings if interest rates rise to 11 percent? What are the net savings if interest rates fall to 3 percent?

c. If, instead, the FI sells (writes) the floor, what are the net savings if interest rates rise to 11 percent? What if they fall to 3 percent?

d. What amount of floors should the FI sell to compensate for its purchase of caps, given the above premiums?

 LO.1