n a floor with quarterly reset dates, the floor rate is 5.0% per annum and the notional principal is $1 million. Suppose that the LIBOR rate is 4.0% per annum for a particular 3-month period. What is the approximate payoff from the floor at the end of the 3-month period? (Reminder: all the rates quoted are annual rates with quarterly compounding) A. $1,250 B. $0 C. $2,500 D. $10,000

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Business

Neil

11 October, 03:14

n a floor with quarterly reset dates, the floor rate is 5.0% per annum and the notional principal is $1 million. Suppose that the LIBOR rate is 4.0% per annum for a particular 3-month period. What is the approximate payoff from the floor at the end of the 3-month period? (Reminder: all the rates quoted are annual rates with quarterly compounding) A. $1,250 B. $0 C. $2,500 D. $10,000

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Giancarlo Branch · Answer 1

C. $2,500

Explanation:

As we got a floor, this protects from a decrease in rate. In this case, we have a floor of 5% and the variable rate drop to 4% which is below the floor so the floor triggers:

We are asked for how much interest revenue were saved by the floor:

rate differences: floor - actual = 0.05 - 0.04 = 0.01

now we calcualte the interest as usual:

principal x rate x time = payoff

1,000,000 x 0.01 x 3/12 = 2,500