Consider a company that borrows in the floating-rate instrument market

Consider a company that borrows in the floating-rate instrument market. It takes out a $10 million one-year loan on 1 March. The loan is an interest-only loan, requiring

quarterly interest payments on the first day of each corresponding month: 1 June, 1

September, 1 December, and 1 March of the following year, with the full principal

payment at the end. The interest rate is 90-day LIBOR plus 200 basis points. Current

90-day LIBOR is 7 percent, which sets the rate for the first three-month period at 9

percent. The rates are reset every three months. To protect itself against the risk of

increases in interest rates when the rates are reset, the company purchases an interest

rate cap with an exercise rate of 7.25 percent. The component caplets expire on the

rate reset dates. The cap premium, paid up front on 1 March, is $25,000. Determine the effective interest payments if LIBOR on the following dates is as given:

1 June: 7.25 percent

1 September: 7.50 percent

1 December: 8.00 percent