Question 5 A bank is a lender in the floating-rate instrument market. It uses fixed-rate financing on its floating-rate loan and buys floors to hedge the rate. It makes a R20 million one-year loan on 16 July. The loan is an interest-only loan, requiring quarterly interest payments on the 16th day of each corresponding month: 16 October, and 16 January, 16 April and 16 July of the following year, with the full principal payment at the end on 16 July of the following year. The interest rate is 90-day LIBOR plus 150 basis points. Current 90-day LIBOR is 5.75 percent, which sets the rate for the first three-month period at 7.25 percent. The rates are reset every three months. To protect itself against the risk of decreases in interest rates when the rates are reset, the bank purchases an interest rate floor. The component floorlets expire on the rate reset dates. LIBOR on the following dates turn out to be as given: 16 October: 16 January: 16 April: 5.00 percent 5.25 percent 5.50 percent Determine the effective interest payments if the bank had purchased a floor with an exercise rate of 5.50 percent, with a premium of R50,000 paid up front on 16 July (9)