Case:

Author:

CapIT Corporation Case on Applying SFAS 133 to a Eurodollar Option Used to Cap a Forecasted Loan Transaction
Bob Jensen at Trinity University http://www.trinity.edu/rjensen

Abstract:

On June 17, 1999 CapIT Corporation had a forecasted transaction to borrow $25 million in three
months at a variable rate. The CFO of Capit, Todd Evert, commenced to worry about rising interest
rates following the cessation of NATO bombing in Kosovo. Signs pointed to rising prices that may
lead to world wide rises in borrowing costs.
Todd decided to purchase 25 September Eurodollar interest rate options in order to place a cap

LIBOR Premium % Premium $

4.90%
0.85%
$53,125
5.00%
0.85%
$53,125
5.10%
0.85%
$53,125
5.20%
0.85%
$53,125
5.30%
0.85%
$53,125
5.40%
0.85%
$53,125
5.50%
0.85%
$53,125
5.60%
0.85%
$53,125
5.70%
0.85%
$53,125
5.80%
0.85%
$53,125
5.90%
0.85%
$53,125
6.00%
0.85%
$53,125
6.10%
0.85%
$53,125
6.20%
0.85%
$53,125
6.30%
0.85%
$53,125
6.40%
0.85%
$53,125

Loan Rate
6.20%
6.30%
6.40%
6.50%
6.60%
6.70%
6.80%
6.80%
6.80%
6.80%
6.80%
6.80%
6.80%
6.80%
6.80%
6.80%

LIBOR 9425 Strike 9450 Strike 9475 Strike

3.00%
3.45%
3.45%
3.45%
3.50%
3.95%
3.95%
3.95%
4.00%
4.45%
4.45%
4.45%
4.50%
4.95%
4.95%
4.95%
5.00%
5.45%
5.45%
5.45%
5.50%
5.95%
5.95%
5.95%
6.00%
6.45%
6.45%
6.45%
6.50%
6.45%
6.80%
6.95%
7.00%
6.45%
6.80%
7.45%
7.50%
6.45%
6.80%
7.95%

Exhibit 2: Capped Loan Rate on

9,450 June 17 Put Option Strike P

7.00%
6.80%
6.60%
6.40%
6.20%
6.00%
5.80%

5.50% strike rate

Exhibit 3: Comparison of Capped L

Rates of Three Put Option Strike Pr
10.00%
8.00%
6.00%

6.00%
8.00%
8.50%
9.00%
9.50%
10.00%

5.75%
5.50%
5.25%
5.00%
4.75%
4.50%

6.45%
6.45%
6.45%
6.45%
6.45%

6.80%
6.80%
6.80%
6.80%
6.80%

8.00%
8.00%
8.00%
8.00%
8.00%

0.25%
0.85%
2.30%
4.45%
6.90%
9.40%

$15,625
$53,125
$143,750
$278,125
$431,250
$587,500

6.45%
6.80%
8.00%
9.90%
12.10%
14.35%

4.00%
2.00%
0.00%

5.75 6.80

8.00

Date

o a Euroansaction

1999
June 17

June 30

July 31

Aug. 31

pped Loan Rate on a

ut Option Strike Price

0% strike rate

Sept. 17

Sept. 17

LIBOR
Dec. 17

arison of Capped Loan

ut Option Strike Prices

9425 Strike
9450 Strike

9450 Strike
9475 Strike

LIBOR%

Debit
(Credit)

Balance

(53,125)
53,125

(53,125)
53,125

Cash
Options contracts
Interest expense (revenue)
Other comprehensive income (OCI)
--To record value adjustment of option contracts

(18,750)
(6,250)
25,000

(53,125)
34,375
(6,250)
25,000

Cash
Options contracts
Interest expense (revenue)
Other comprehensive income (OCI)
--To record value adjustment of option contracts

26,250
(8,750)
(17,500)

(53,125)
60,625
(15,000)
7,500

Cash
Options contracts
Interest expense (revenue)
Other comprehensive income (OCI)
--To record value adjustment of option contracts

(5,000)
51,875
(46,875)

(53,125)
55,625
36,875
(39,375)

62,500
(55,625)
(36,875)
30,000

9,375
0
0
(9,375)

CapIT Corporation Accounts

Cash
Options contracts
Interest expense (revenue)
Other comprehensive income (OCI)
--To record purchase of 50 put option contracts

Cash
Options contracts
Interest expense (revenue)
Other comprehensive income (OCI)
--To record option contract settlement
Cash
Options contracts
Notes payable
Interest expense (revenue)
Other comprehensive income (OCI)
--To record loan transaction for $25 million

25,009,375
0
(25,000,000) (25,000,000)
0
(9,375)

Cash
Options contracts
Notes payable
Interest expense (revenue)
Other comprehensive income (OCI)
--To record payoff of $25 million loan

(25,434,375)
0
25,000,000
425,000
9,375

CapIT Corporation Summary

Interest expense without hedging

25,000,000

434,375

(425,000)
0
0
425,000
0

Net income from put option hedges

Interest expense with hedging

(9,375)
425,000

Teaching Note With Answers to Questions

Case:

Author:

CapIT Corporation Case on Applying SFAS 133 to a Eurodollar Option Used to Cap a Forecasted Loan Transaction
Bob Jensen at Trinity University http://www.trinity.edu/rjensen