# Caplet/Floorlet Computation Question

On April 15, Bank buys a One year floating rate loan for \$10 Million. Int payments=quarterly LIBOR+200bps. 9 Month, quarterly pay floor with strike rate of 8.5%. LIBOR is 8% on April 15, 8.4% on October 15, 8.65% on January 15, 8.4% on April 15.

Why is there no floor payoff on July 15? If there is a payment on July 15 (using April 15’s LIBOR) then why isn’t there a floor payment?

Schweser’s explanation is “Because the first loan interest payment is known at initiation of the analysis, so the first floorlet expires July 15 with payoff on October 15.”

Can somebody explain this another less confusing way?

I think it’s because the firm has a 12 month loan but only a 9 month floorlet (series of floorlets). The floorlet is being used to provide protection for future unexpected rate drops. If the first interest rate is already known, there’s no point in buying a floorlet as the value of it will equal the cost (otherwise there could be arbitrage).

These payments are based on the LIBOR in the previous period so the first cap/floor, which is based on the LIBOR rate today should have no value otherwise there will be arbitrage oppotunity like matt mentioned.