Question

A British company BB Corp. enters into a 1-year interest rate swap with Sea Bank. The notional principle of the swap is £60 million. Payments will be made quarterly on the basis of 90/360 (90 days in the settlement period and 360 days per year). BB will receive a fixed rate of 3.5% and pay floating rate Euribor plus 1%. The 90-day Euribor rates are as below:

Current: 2.4%             In 1 quarter: 3%          In 2 quarters: 3.5%      In 3 quarters: 3.7%

A. Determine the initial exchange of cash that occurs at the start of the swap.  

B. Determine the quarterly payments (Q1, Q2)

C. Determine the final exchange of cash that occurs at the end of the swap.

Answer 1

A. As this is a plain vanilla Interest rate swap, no exchange of notional principal is required initially

So, there is no exchange of Cash at the start of the Swap

B. After Q1,

Amount received by BB = 3.5% for 90 days on  £ 60 million

Amount payable by BB = ( 2.4%+1%) for 90 days on £ 60 million

=3.4% for 90 days on £ 60 million

So, BB will receive Net 0.1% for 90 days on £ 60 million   

=0.1/100* 90/360 * £ 60 million   

= £0.015 million = £15,000 from Sea Bank

After Q2,

Amount received by BB = 3.5% for 90 days on  £ 60 million

Amount payable by BB = ( 3%+1%) for 90 days on £ 60 million

=4% for 90 days on £ 60 million

So, BB will pay Net 0.5% for 90 days on £ 60 million   

=0.5/100* 90/360 * £ 60 million   

= £0.075 million = £75,000 to Sea Bank

After Q3,

Amount received by BB = 3.5% for 90 days on  £ 60 million

Amount payable by BB = ( 3.5%+1%) for 90 days on £ 60 million

=4.5% for 90 days on £ 60 million

So, BB will pay Net 1% for 90 days on £ 60 million   

=1/100* 90/360 * £ 60 million   

= £0.15 million = £150,000 to Sea Bank

After Q4,

Amount received by BB = 3.5% for 90 days on  £ 60 million

Amount payable by BB = ( 3.7%+1%) for 90 days on £ 60 million

=4.7% for 90 days on £ 60 million

So, BB will pay Net 1.2% for 90 days on £ 60 million   

=1.2/100* 90/360 * £ 60 million   

= £0.18million = £180,000 to Sea Bank

c) There is no cash flow exchange of principals at the end of swap except for the exchange of interest payments at the end of Q4 when BB pays £180,000 to Sea Bank.