5. The Acme Insurance Company purchased a 5-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...

5. The Acme Insurance Company purchased a 5-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 the insurance company purchases this bond, it enters into a floor agreement with the Bear Stearns in which the notional amount is $35 million with a strike price of 6%. The premium Acme Insurance Company agrees to pay Bear Stearns each year is $300,000

a) Suppose at the time that it is necessary to determine whether a payment must be made by Bear Stearns, LIBOR is 9%.

How much must Bear Stearns pay to Acme Insurance Company?

b) Suppose at the time that it is necessary to determine whether


a payment must be made by Bear Stearns, LIBOR is 3%. How much Bear Stearns pay to Acme Insurance Company?

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