Question

. Consider the following interest-rate swap:

• the swap starts today, January 1 of year 1 (swap settlement date)

• the floating-rate payments are made quarterly based on actual / 360

• the reference rate is 3-month LIBOR

• the swap rate is 6%

• the notional amount of the swap is $40 million

• the term of the swap is three years

(a) Suppose that today’s 3-month LIBOR is 5.7%. What will the fixed-rate payer for this interest rate swap receive on March 31 of year 1 (assuming that year 1 is not a leap year)?

(b) What will the fixed-rate payer for this interest rate swap pay on March 31 of year 1 (assuming that year 1 is not a leap year)?

Answer 1

Interest rate swap by definition is a contract where two parties agrees to exchange the cash flows. In the most basic IRS ( interest rate swap) two parties exchange the fixed interest obligation against the floating cash flows. The basic reason for entering this contract is the market expectations where one party expect the floating rate to be lower and other believe the opposite.

There are some terms related to the IRS.

Reference rate- This is the flowing leg of the IRS usually can be LIBOR, CPI or any other floating rate

Swap rate- This is the fixed commitment.

Present question

Swap start date – 01/01/2019

Reference rate-3 month LIBOR.

Swap Rate/ Fixed rate= 6%

Notational amount -$40,00,000

Swap term 3 years

1. Suppose that today’s 3-month LIBOR is 5.7%. What will the fixed-rate payer for this interest rate swap receive on March 31 of year 1 (assuming that year 1 is not a leap year)?

Fixed rate payer has agreed to receive the floating leg so in this case is notional*5.7%

$40,000,000 *5.7% =$2,280,000

2. What will the fixed-rate payer for this interest rate swap pay on March 31 of year 1 (assuming that year 1 is not a leap year)?

Fixed rate payer has agrees to pay the fixed interest in return of the floating rate. In this case he will pay

Notional * Fixed rate which is $40,000,000*6% =2,400,000