Interest rate put on a floatin rate loan question, interest, financing, buying

John10

Pg. 443 of cfai volume 5 states a cAse where a bank buys a interest rate put to hedge a floating rate loan to be made. It states the bank has secured fixed rate financing in order to originate the loan which will be made at libor+100bps My question is, when calculating the option cost, why do they incorporate the 100 spread on the fixed rate loan since the bank is borrowing at a fixed rate? Im thinkig it's to incorporate the opportunity cost associated with buying the option? It just doesn't make sense tO me since the bank is borrowing at 7.125 fixed not the latter plus 100

aidebaobao

jorgeam86 Wrote:
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> Pg. 443 of cfai volume 5 states a cAse where a
> bank buys a interest rate put to hedge a floating
> rate loan to be made. It states the bank has
> secured fixed rate financing in order to originate
> the loan which will be made at libor+100bps My
> question is, when calculating the option cost, why
> do they incorporate the 100 spread on the fixed
> rate loan since the bank is borrowing at a fixed
> rate? Im thinkig it's to incorporate the
> opportunity cost associated with buying the
> option? It just doesn't make sense tO me since the
> bank is borrowing at 7.125 fixed not the latter
> plus 100

Opportunity cost of being able to lend the funds at the full rate.

Even if they are borrowing at 7.125 they could lend at XXXX which is >7.125.