Question

Assume that you are a swap dealer and have just acted as a counterparty in an interest rate swap. The notional principal for the swap was $7.5 million and you are now obligated to make five annual payments of 8% interest. The floating rate that you will receive annually is LIBOR + 2%. (a.) If the LIBOR is 6.2% and does not change over the next 5 years, what will be your annual net inflow? (b.) What is the net present value of your swap agreement at a discount rate of 8%? (c.) If the floating rate stays the same for the first two years and then falls by 1.5%, what will be your net payments for the five years? Calculate the present value of the cash flows at a discount rate of 8%. 2. A swap agreement covers a 5-year period and involves annual interest payments on a JPY1 million principal amount. Party A agrees to pay a fixed rate of 10% to Party B; while Party B agrees to pay a floating rate of LIBOR + 2% to Party A. The LIBOR is 9% at the time of the first payment. What is the net payment between the two interest obligations? 3. Assume that the current spot rate for the Swiss franc is SF 1.5/$, the US interest rate is 9%, and the Swiss interest rate is 8%. Firm X wishes to exchange 30 million Swiss francs for dollars. In return for these Swiss francs, Firm Y would pay $20 million to Firm X at the initiation of the swap. The term of the swap is three years and the two firms will make annual interest payments. If the spot rate at the end of year 1 changes to SF1.7/$, what is the net payment for year 1?

Answer 1

Answer:

1.

Notional principal	7,500,000
Fixed rate	8%
Floating rate	LIBOR + 2%

a) & b)
LIBOR = 6.2%
Year	Fixed interest(outflow) 8%	Floating interest(inflow) 8.2	Annual Net Inflow	PVAF@8%	PV Cash inflows
1	600,000	615,000	15,000	0.9259	13,889
2	600,000	615,000	15,000	0.8573	12,860
3	600,000	615,000	15,000	0.7938	11,907
4	600,000	615,000	15,000	0.7350	11,025
5	600,000	615,000	15,000	0.6806	10,209
					59,891

c)
LIBOR = 6.2% for 2 years and 4.7% for rest of the years
Year	Fixed interest(outflow) 8%	Floating interest(inflow) 8.2%;6.7%	Annual Net Inflow	PVAF@8%	PV Cash inflows
1	600,000	615,000	15,000	0.9259	13,889
2	600,000	615,000	15,000	0.8573	12,860
3	600,000	502,500	(97,500)	0.7938	(77,399)
4	600,000	502,500	(97,500)	0.7350	(71,665)
5	600,000	502,500	(97,500)	0.6806	(66,357)
					(188,672)

2.

Notional principal = JPY 1,000,000
LIBOR (given) = 9%   
Floating rate = 9%+2% = 11%  

	Party A	Party B
Fixed interest (10%*1000000)	(100,000)	(110,000)
Floating interest (11%*1000000)	110,000	100,000
Net payment(JPY)	10,000	(10,000)

3.

Particulars	CHF
X pays interest on dollar loan ($20*9%*1.7)	3,060,000
X receives Interest in CHF from Y (CHF30*8%)	2,400,000
Net payment by X	660,000
	$
Y pays interest in CHF (CHF30*8%/1.7)	1,411,765
Y receives Interest in $ from Y ($20*9%)	1,800,000
Net Receipt by Y	388,235