Riddle me this - Interest Rate Floor... discounted, absolute, interest, position, present

svgleeson

Schweser Book 1, Exam 3PM, Question 93....

If 1-year LIBOR at the end of year 2 is 5.8%, the absolute value of a position (long or short) in the 2-year, 6%, $30,000,000 interest rate floor at the end of year 2 is closest to:

a) $ 56,711
b) $ 60,000
c) $ 63,480

Answer is A. The explanation makes NO sense to me....

"The floor pays off in arrears, so the $60,000 payoff is made at the end of the 3rd year, and the floor value at maturity is the present value of the $60,000 payoff discounted 1 year at 5.8%."

WTF are they talking about with this "3rd year" and paying in arrears. WTF?!??!

mengxu

it is a 6% floor.
LIBOR at the end of the 2nd year is 5.8%.
Difference between 6% and 5.8% discounted at 5.8% will be the Floor's payoff in the 3rd year. The 5.8% at the end of the 2nd year - is applicable to payoff in the 3rd year.

30 Mill * (0.06 - 0.058) / (1.058) = 56710.77

CP