EURIBOR level, setting

The result for the company is that EURIBOR will effectively be collared in the range 2.50% to 3.50%. If EURIBOR ever rose above 3.50%, the company s costs would be capped at that level. The downside is that whenever the EURIBOR setting was below 2.50%, the company would not pay less. As neither the cap nor the collar include the first interest period, the company in this example is assured of six months borrowing based on a EURIBOR of 2%. Thereafter, even if EURIBOR were to stay low, the company s borrowing would be based on a EURIBOR of at least 2.50%. This may nonetheless still prove less expensive than paying the fixed rate of 3% throughout, which is what the swap would involve. 

For example, suppose the ratchet cap initially had a strike rate of 3%, and a spread of 50 bp. So long as EURIBOR stayed below 3%, the caplets would expire out-of-the-money, and the strike rate would remain at 3%. The first time that EURIBOR sets above 3%, however, the expiring caplet would result in a payment to the owner of the cap, but the strike rates for all the remaining caplets would be reset to 3.5%. The cap would therefore not pay out again until rates rose to this higher level, whereupon the strike rate would be ratcheted up to 4%, and so on. 

The cash flows for this transaction are set forth in Exhibit 19.1. The second column of the exhibit shows the cash flows from purchasing the 5-year floating-rate bond. There is a 50 million cash outlay and then 10 cash inflows. The amount of the cash inflows is uncertain because they depend on future levels of 6-month EURIBOR. The next column shows the cash flows from borrowing 50 million on a fixed-rate basis. The last column shows the net cash flows from the entire transaction. As the last column indicates, there is no initial cash flow (no cash inflow or cash outlay). In all 10 6-month periods, the net position results in a cash... 

FRNs can have additional features, such as flbors, which specify minimum levels below which the coupon cannot fall caps, which specify maximum rates and calls, which specify possible redemption dates before maturity. Perpetual FRNs also exist. As in other markets, borrowers frequently issue floating notes with specific, even esoteric, terms to meet particular requirements or customer demands. For example. Citibank issued a series of U.S. dollar—denominated FRNs indexed to the Euribor rate and another set of notes whose day count was linked to a specified LIBOR range. 

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See also in sourсe #XX -- [ ]

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