Question

A F/IF security is created with $20,000,000 in principal and a WAC of 7%. 40% of the principal is allocated to the floater class and the remainder is allocated to the inverse floater class. The floater class will receive LIBOR+50bp.

C. What is the maximum cap rate payable to the floater class?

Express your answer as a percentage rounded to two decimal places (i.e. three and three quarters would be 3.75)

Answer 1

WAC = 7%
Allocation to Floater Class = 40%, Allocation to inverse floater class = 60%
Floater rate = Libor + 50bps = Libor + 0.5%= 0.005
Let Inverse floater rate = x

(Weight of Floater class * Floater Rate) + ( Weight of Inverse Floater class* Inverse floater rate) = WACC
(40%*(libor+0.005) + 60%* x) = 7%
0.4* libor + 0.002 +0.6x = 0.07
0.4 libor = 0.07-0.002 - 0.6x
0.4 libor = 0.068 - 0.6x ( For Max Libor Value X should 0)
Libor = (0.068-0.6*0)/0.4 = 0.17
Max cap rate payable to floater class = Libor + 50 bps = 0.17 + 0.005 = 0.175 or 17.50%

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