Question

5. You want to enter a pay-fixed, receive-floating interest rate swap with a notional amount of $15 million and quarterly payments for one year. Interest calculations will use a 90/360 convention. The yield curve is as follows:Term Rate

90 3.0%

180 3.2%

270 3.3%

360 3.5%

a. (5 points) What is the correct fixed rate term for this swap?

b. (5 points) In 90 days, how much money will you pay or receive (net)?

c. (5 points) Assume that you entered the swap contract on initiation date at the fair rate that you calculated in Part A, and 60 days later the yield curve is as follows: Term Rate

30 3.50%

120 3.75%

210 3.90%

300 4.00%

What is the value of the swap to you (paying fixed and receiving the floating rate)?

Answer 1

First of all we have to understand that this is Plain vanilla Swap or Generic Swap, thats why we will pay the Fixed intterest and in other Leg we will receive the Floating.

(a) We are given the Floating Rates so to answer the question we have to calculate the intterest which we will receive.

Intterest for 1st qtr-15mill*3%*91/360=113750

Intterest for 2nd qtr-15mill*3.2%*91/360=121333

Intterest for 3rd qtr-15mill*3.3%*91/360=125125

Intterest for 4th qtr-15mill*3.5%*91/360=132708

So the Average Intterest received over the 1 Year period= sum of above/4=492916/4=123229

Now to calculate the Fixed Intterest rate we have to equate by assuming that the Floating Payment and Fixed payment are equal.

15mill*Fixed Intterest Rate(X %)*90/360=123229

By solving this Fixed Intterest rate=3.29%(ANSWER TO a)

NOTE:- TO CALCULATE THE FLOATING INTTEREST RATE WE HAVE TAKEN 91 DAYS BECAUSE THE FLOATING RATE ARE MADE AT THE BEGINING OF EVERY PERIOD.

(b) We can easily calculate the net payment or net received ffor each 90 day period.

Just take the Fixed Intterest Rate as 3.29% and calculate the Floating Intterest for each term of 90 days.