QUESTIONS 25 THROUGH 30 RELATE TO RISK MANAGEMENT APPLICATION OF DERIV...

4. Frank O’Conner is the owner of a national tire manufacturing business. To fund business expansion, he has received a 4-year $12 million loan from a local bank. Interest will be paid semi-annually at a rate of 200 basis points over the current LIBOR. O’Conner is wary of rising interest rates and has come to Jose for a solution. Jose recommends the purchase of a series of 6-month caplets with expiration dates of 15 October and 15 April for the next year, and so on for the next five years, and an exercise rate of 11%. The number of days in and LIBOR during the first three settlement periods has been compiled by Jose (Exhibit 1). Current LIBOR is 10% and the cap premium is $65,000. Exhibit 1 Number of Days in Settlement Period And LIBOR Term Structure Settlement Period Number of Days LIBOR (%) 15 October 183 9.25 15 April 182 11.50 15 October 183 11.80