Question

Swaps

A. What is the cash flow position for Company A Year 1-4?

B. What is cash flow position for Company B Year 1-4?

Company A borrows $600,000 from Lender 1. The loan demands interest-only be paid and it is a variable term based on the U.S. 10-year bond plus 1%. Company B borrows $600,000 from Lender 2. The loan is fixed at 3% and requires payment of interest-only.

Y1	Y2	Y3	Y4
2.0%	1.5%	1.75%	2.75%

After Year 2, Company A enters into an agreement with Company B, wherein each of them agree to exchange interest cash flows that arise from a notional amount of $350,000, as follows: Company A agrees to pay Company B a fixed rate of 2.5% of the notional amount. These cash flows will happen in Years 3 and 4. Also, Company B agrees to pay Company A a variable rate of the 10-year US Bond rate plus 0.50%, of the notional amount. These cash flows will happen in Years 3 and 4.

Answer 1

Please see the below calculation :

Cash position will remain same if company A and B agree in to Swap. This is due to less variation on the interest.

	Borrowed Amount	600000
		Y1	Y2	Y3	Y4	Total Interest
	Company A Interest Rate	3.00%	2.50%	2.75%	3.75%
	Company B	3%	3%	3%	3%
Normal Scenerio if there is no SWAP
Interest Payment	Company A	18000	15000	16500	22500	72000
	Company B	18000	18000	18000	18000	72000
After Agreement	Notional Amount (Swap)		350000
	Amount of Normal Interest		250000
	Company A(Notional Amount - Balance)		1750	1750	1750	1750
	Company B(Notional Amount - Balance)		1750	1750	1750	1750
Swap	Company A (Notional Amount)		8750	8750	8750	26250
Company B (Notional Amount )		7000	7875	11375	26250
	Company A (Balance Amt without Agreement)	18000	6250	6875	9375	40500
	Company B (Balance Amt without Agreement)	18000	7500	7500	7500	40500