A Spanish pension fund is considering buying a five-year floating-rate note named "El Oso Grande." El Oso Grande would have a coupon reset formula of three times six-month (Spanish peseta) LIBOR minus 24 percent, subject to a minimum coupon rate of 0 percent if peseta LIBOR were to fall below 8 percent. Currently, six-month peseta LIBOR is 11.20 percent, so the initial coupon would be based on a rate of 9.60 percent. The five-year, semiannual payment, 100 million peseta floating-rate note can be bought at par value. The pension fund intends to use derivative instruments to convert El Oso Grande into a synthetic fixed-rate asset. Quotes for five-year, semiannual settlement interest rate swaps, caps, and floors on six-month Spanish peseta LIBOR are obtained from a Madrid commercial bank specializing in derivative products.

Interest Rate Swaps:

The pension fund can pay a fixed rate of 13.50 percent and receive six-month peseta LIBOR, or the fund can receive a fixed rate of 13.35 percent and pay six-month peseta LIBOR

Interest Rate Caps:

Strike Rate The Fund Buys the Cap The Fund Writes the Cap 24% 125 BP 90 BP

Interest Rate Floors:
Strike Rate The Fund Buys the Floor The Fund Writes the Floor 8% 175 BP 140 BP

(Recall that the premiums on the caps and floors are quoted as a percentage of the notional principal.)

a. Indicate the specific combination of transactions that provides a synthetic fixed-rate asset to the pension fund.

b. Calculate the "all-in," fixed rate of return. Assume that Spanish peseta LIBOR, the coupon rate on El Oso Grande, the swap fixed rate, and the strike rate on the caps and floors are all stated on a semiannual bond basis.