The American Commerce Bank (ACB) lends $1.25 million to Unity International Comp

Question

The American Commerce Bank (ACB) lends $1.25 million to Unity International Company for 3 months. The bank usually changes a rate of LIBOR plus 3 percent to companies with similar credit ratings. However, since the bank's economists are of the view that short-term interest rates may fall in the near future, ACB decided to lend money to Unity at a discounted rate of LIBOR plus 2 percent in return for an interest-rate floor of 4.25 percent. What amount of interest rebate will the bank receive, if LIBOR drops to 1.25 percent from 2.25 percent immediately after lending the amount?

Can you please put down the calculation to solve this problem

Explanation / Answer

Interest amount that the bank shall receive if LIBOR is 2.25% = $ 1.25 Million x (2.25 + 2.00)% x 3 / 12

                                                                                         = $ 13,281.25

Interest amount that the bank shall receive if LIBOR drops to 1.25% in case there are no floors = $ 1.25 Million x (1.25 + 2.00)% x 3 / 12

                                                                                         = $ 10,156.25

Since, there is an Interest Rate Floor, the bank shall receive an interest of 4.25% even if LIBOR drops to 1.25%

Then, Interest Rebate = $ 13,281.25 - $ 10,156.25

                                = $ 3,125

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