# solution

Create a floating and an inverse floating tranches secured by \$100 million in par bonds with a coupon rate of 5.0% paid annually for five years. The market rate on a floater is the one year T-bill rate (reference rate). The quoted margin (a) is zero. This floater has a floor of 2% and a cap of 8%. The floating rate tranche has a maturity of five years and the floating rate is reset every year.

1. If the leverage factor (L) equals 1design both the floating rate and inverse floating rate tranches . The par value of the inverse floater tranche in millions of dollars) is :

2. If the leverage factor() equals , the constant in percent) equals:

3. If the leverage factor (L) equals 1, the floor (in percent) on the inverse floater equals:

4 If the leverage factor (L) equals 1, the cap (in percent) on the inverse floater equals

5. Suppose the market value of the underlying bonds drops by \$5 million at the next reset reset date. The credit risk of the underlying collateral does not change. If the leverage factor () equals 1compute the value of the inverse floater (in millions of dollars) at the next reset date

6. If the leverage factor (L) equals 1.5, design both the floating rate and inverse floating rate tranches. The par value of the inverse floater tranche (in millions of dollars) is:

7. If the leverage factor (L) equals 1.5, the constant in percent) equals

8. If the leverage factor (L) equals 1.5the floor (in percent) on the inverse floater equals

9. If the leverage factor (L) equals 1.5the cap (in percent) on the inverse floater equals

10. Suppose the market value of the underlying bonds drops by \$5 million at the next reset reset date. The credit risk of the underlying collateral does not change. If the leverage factor () equals 1.5, compute the value of the inverse floater (in millions of dollars) at the next reset date.

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