# effective annual rate

One of Devon’s clients is planning to acquire a competing firm in 109 days. The acquisition will initially be financed by a USD 80,000,000 bridge loan with a term of 180 days and a rate of 180-day Libor plus 300 bps. Principal and interest will be paid at the end of the loan term. The client is concerned about a potential increase in interest rates before the initiation of the loan, and asks for advice on fully hedging this interest rate risk. A derivatives analyst at Devon advises the client to buy an interest rate call option on 180-day Libor with an exercise rate of 2.0% for a premium of USD 86,000. The call expires in 109 days and any payoff occurs at the end of the loan term. Current 180-day Libor is 2.2%. The client can finance the call option premium at current 180-day Libor plus 300 bps. At initiation of the loan 109 days later, 180-day Libor is 3.5%.

Calculate the effective annual rate (in bps) on the loan. Show your calculations.

This question does give 109-day Libor. How to get the compounded cost of option premium in 109 days when option expires?

The question does not give 109 day libor because there’s no such thing… It gives 180-day libor annualized rate. You solve this like all the other questions that deals with libor and interest rates such as swap calucations.

109/360 * (Libor + 300bps).

The text shows multiple examples of doing that.