Question 5 2016:

ABC Bank raises funding through fixed rate retail bonds and lends to clients for periods of up to 5 years on a floating rate basis. On 16th July it raised US$50 million in a 1-year bond at a coupon of 4% and lent the entire sum on the same day to a client for 1 year at a margin of 75 basis points above 3-month LIBOR. Both the bond and the loan are due for repayment on a bullet basis, with interest payable quarterly in arrears. In order to protect itself against falling interest rates, ABC Bank also purchased an interest rate floor on 16th July at 3.5% for the entire period at a cost of 3bp. Assume that 3-month LIBOR is set at the following rates for each of the interest periods: Period 1: 3.75% Period 2: 3.50% Period 3: 3.25% Period 4: 3.15% Required: (i) Calculate the net income to ABC Bank for this transaction. Notes: Assume that each 3-month period expires on a business day. Each interest period should be calculated on the actual number of days expired (i.e. actual daysumber of days in a year). All payments are due on the last day of the relevant interest period. Ignore any capital requirements connected with the transaction. An