A firm is short a LIBOR participating cap at a strike rate of 8% with participation rate of 80%. LIBOR rises to 10%. Determine the firm's payment to the counterparty.
Solution: 10% - 8% = 2% excess of LIBOR. 80% of 2% is 1.6%, which is what the firm pays. I understand that. But it goes on to say that since LIBOR is 10%, the final answer is "16% of LIBOR".
I don't understand exactly how we got 16% of LIBOR. It seems that we multiplied 1.6% by 10, and 10 coming from the 10% of LIBOR. But since both numbers come as a percentage, I am confused. Can someone explain? Thanks.
Solution: 10% - 8% = 2% excess of LIBOR. 80% of 2% is 1.6%, which is what the firm pays. I understand that. But it goes on to say that since LIBOR is 10%, the final answer is "16% of LIBOR".
I don't understand exactly how we got 16% of LIBOR. It seems that we multiplied 1.6% by 10, and 10 coming from the 10% of LIBOR. But since both numbers come as a percentage, I am confused. Can someone explain? Thanks.
'Participating cap' problem