You are a funds manager for a large bank. On April 15, your bank lends a corporation $35 million, with interest payments to be made on July 16, October 15, January 16, and next April 16. The amount of interest will be determined by LIBOR at the beginning of the interest payment period. On April 15, LIBOR is 8.0 percent. Your forecast is for declining interest rates, so you anticipate lower loan interest revenues. You decide to buy an interest rate floor with a strike set at 8 percent and a premium of $60,000. Determine the cash flows associated with the loan if LIBOR turns out to be 7.9 percent on July 16, 7.7 percent on October 15, and 8.1 percent next January 16. The payoff is based on the exact number of days and a 360-day year.

Optional: If you have a financial calculator or spreadsheet with an IRR function, solve for the internal rate of return and annualize it to determine your annualized return on the loan.

Interest Floor Principal Net Without Floor Net

Date Days LIBOR Received Payment Repayment Cash Flow Cash Flow

4/15 8.00 60,000 0 35,060,000 35,000,000

7/16 92 7.90

10/15 91 7.70

1/16 93 8.10

4/16 90