You Are Currently Borrowing €10 Million at Three-Month Euribor

Essay

You are currently borrowing €10 million at three-month Euribor + 75 basis points. The Euribor is
at 3%. You expect to borrow this amount for five years but are worried that Euribor will rise in the future. You can buy a 4% cap on three-month Euribor over the next five years with an annual cost of 0.75% (paid quarterly). Describe the evolution of your borrowing costs under various interest rate scenarios (i.e., above and below 4%).