Suppose UK Trust plans to invest $15 million in a two-year FRN paying LIBOR.

The FRN starts on 3/20 at 7.5% and is then reset the next seven quarters on 6/20, 9/20, and 12/20. UK Trust would like to establish a floor on the rates it obtains on the note. A money center bank is offering UK a floor for $200,000 with the following terms corresponding to the floating-rate note:

 The floor consists of seven floorlets coinciding with the reset dates on the note  Exercise rate on the floorlets = 7%
 Notional principal = $15 million  Reference rate = LIBOR  Time period on the payoffs is .25  Payoff is paid on the payment date on the note  Cost of the floor is $100,000 and is paid on 3/20 UK would like to finance the $200,000 cost of the floor by forming a reverse collar by selling a cap. The money-center bank is willing to buy a cap with an exercise rate of 8% from UK for $150,000 with similar terms to the floor.

a. Evaluate a reverse collar-hedged FRN investment UK could form with the cap and floor offered by the money center bank given the following interest-rate scenarios: LIBOR = 7.5% on 3/20/Y1, 7% on 6/20/Y1, 6.5% on 9/20/Y1, 6% on 12/20/Y1, 7% on 3/20/Y2, 8% on 6/20/Y2, 8.5% on 9/20/Y2, and 9% on 12/20/Y2. In your evaluation, include the quarterly interest receipts, cap and floor cash flows, hedged interest revenue, and hedged rate (do not include cost of the floor or revenue from selling the cap).

b. Define another interest rate option position UK Trust might use to defray the costs of its floor-hedged floating-rate investment.