7. Interest rate caps, floors, and collars 1. 2. 3. STEP: 3 of 3 Assume that the Bank of Topeka anticipates that interest rates will increase over the next several years and decides to hedge the interest rate risk on its portfolios by purchasing a three-year interest rate collar, which uses LIBOR as the index used to represent the prevailing interest rate. The interest rate cap specifies a fee of 5 percent of notional principal valued at $100 million with an interest rate ceiling of 7 percent. The interest rate floor specifies a fee of 5 percent of notional principal valued at $100 million and an interest rate floor of 7 percent. Given this information, fill in the table that follows. End of Year 0 1 2 3 5% 9% 11% 7% 7% 7% 0% 2% 4% Information Purchase of Interest Rate Cap LIBOR Interest Rate Ceiling LIBOR’s Percent above the ceiling Payments Received Fee Paid Sale of Interest Rate Floor Interest Rate Floor LIBOR’s Percent below the Floor Payments Made Fee Received 7% 7% 7% 2% 0% 0% $ $ Given the information filled out in the table, the Bank of Topeka’s profit form the transaction after the three-year period is $
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