How much must bear stearns pay

Reference no: EM132179333

Question - The Acme Insurance Company purchased a five-year bond whose interest rate floats with LIBOR. Specifically, the interest rate in a given year is equal to LIBOR plus 200 basis points. At the same time that the insurance company purchases this bond, it enters into a floor agreement with J.P. Morgan in which the notional principal amount is $35 million with a strike of 6%. The premium Acme Insurance Company agrees to pay J.P. Morgan each year is $300,000.

a. Suppose at the time that it is necessary to determine whether a payment must be made by J.P Morgan, the LIBOR is 9%. How much must Bear Stearns pay Acme Insurance Company?

b. Suppose at the time that it is necessary to determine whether a payment must be made by J.P. Morgan, the LIBOR is 3%. How much must Bear Stearns pay Acme Insurance Company?

c. What is the minimum interest rate that Acme Insurance Company locked in each year for the next five years by entering into this floor agreement and buying the five-year bond, ignoring the premium that Acme Insurance Company must make each year?

Reference no: EM132179333

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