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In: Finance

A plain vanilla interest swap has just been arranged between Muscat Electric Company and British Petroleum....

A plain vanilla interest swap has just been arranged between Muscat Electric Company and British Petroleum. Interest will be calculated on a semi-annual basis.

Muscat  Electric Company  needs  a  Euro loan  to buy  equipment  for  its  new  project.  The loan is  required   for  5 years  and amount  is  5 million Euros.   Muscat Electric is  interested in  fixed rate  loan. Muscat electric agreed to pay 12% per year.

British Petroleum  operates in  Oman.  BP   needs a  5 year   5 million  Euro Loan.  BP wants floating rate funds. BP agreed to pay LIBOR+1%.  

The start date of the swap is 1st Jan 2019

Calculate the  exchange of cash flows between  the two parties on the three dates shown in the table

Year

Libor Rate Observed

Muscat Electric Cash Inflow/Outflow

British Petroleum Cash Inflow/Outflow

1st Jan 2019

11%

1st June 2019

12.00%

1st Jan 2020

13.00%

Solutions

Expert Solution

Muscat  Electric Company will pay 12% fixed on 5 million Euros and receive LIBOR+1% on 5 million Euros from BP and BP will receive 12% fixed on 5 million Euros and pay LIBOR+1% on 5 million Euros to Muscat  Electric Company.

the LIBOR rate will be determined at the beginning of the settlement period, so, settlement for first six-month period will happen on 1st June but LIBOR rate for settlement would be 11% of 1st Jan.

on 1st Jan, there will be no cash inflow/outflow. first settlement will happen on 1st Jun for first six-months. there will be no exchange of notional principal of 5 million Euros at the start of the swap on 1st Jan, 2019.

Fixed and LIBOR rates are on annual basis. so for semi-annual basis payments, annual rates will be half of annual rates.

Muscat Electric British Petroleum
Year Libor Rate Observed Notional principal Cash Inflow Cash Outflow Cash Inflow Cash Outflow
1st Jan 2019 11% €5,000,000 €0 €0 €0 €0
1st June 2019 12.00% €5,000,000 €300,000 €300,000 €300,000 €300,000
1st Jan 2020 13.00% €5,000,000 €325,000 €300,000 €300,000 €325,000

on 1st June, first settlement for six-month period will be done. net cash flow will be zero for both parties because they will receive and pay same amount to each other.

on 1st Jan, 2020, second settlement will happen. net cash flow for Muscat  Electric Company will be €325,000 - €300,000 = €25,000 and for BP it would be €300,000 - €325,000 = -€25,000.

Calculations

jeff jeffy answered 1 year ago
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