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Problem - Iowa City Bank purchases a three-year interest rate floor for a fee of 2 percent of notional principal valued at $80 million, with an interest rate floor of 6 percent and LIBOR representing the interest rate index. The bank expects LIBOR to be 6 percent, 5 percent, and 4 percent (respectively) at the end of each of the next three years.
Required -
a. Determine the initial fee paid, as well as the expected payments to be received by Iowa City if LIBOR moves as forecasted.
b. Determine the dollar amounts to be received (or paid) by the seller of the interest rate floor based on the assumed forecasts of LIBOR.
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