Question

1. Vesta Ventures wishes to borrow $10 million for one year. A bank offers an interest-only loan with quarterly interest payments at a floating rate of 90-day Libor plus 90 bps and full principal repayment due at the end of the one-year term of the loan. Vesta also enters a one-year, quarterly payment interest rate swap as the fixed rate payer to hedge interest rate risk. The swap has a notional principal of $10 million, the floating rate is Libor, and the fixed rate is 3.15%. The loan and the swap utilize a 30/360 day count convention.

Assuming 90-day Libor evolves as given below, what is Vesta’s projected loan interest payment, net swap payment, and overall net interest payment on the hedged loan each quarter? (3 points)

Quarter	Libor
0	2.90%
1	3.10%
2	3.25%
3	3.50%
4	3.60%

Answer 1

Vista Ventures entered into an interest rate swap to hedge interest payment for each quarter @ LIBOR +0.9%

Vista Ventures will pay on loan interest @ LIBOR +0.9% + LIBOR due to interest rate swap and recieve Fixed interest

of 3.15% with a notional capital of $10m

So , its effective cost = LIBOR +0.9%-LIBOR +3.15%

= 4.05%

IST QARTER:

LIBOR turns out to be 3.10% * 90/360 = 0.7750%

Therefore Interest payment =0.7750+0.9 = 1.675%

Projected loan interest = $10 m *1.675%

= $0.1675m

Net swap payment = Getting 3.10% and giving 3.15%

ie net paying 0.15% = $10m *0.15%*90/360

= $0.00375m

Effective cost = $10m * 4.05%*90/360

= $0.10125m

Overall net interest payment=$(0.10125+0.1675)m

= $0.26875m

2nd QUARTER:

LIBOR turns out to be 3.25%*90/360=0.8125%

Therefore interest payment = 0.8125+0.9% = 1.7125%

Projected loan interest payment = $10m*1.1725%

= $0.17125m

Net swap payment = giving 3.25% and getting 3.15%

ie net payment = 0.10%*$10m*90/360

= $0.0025m

Effective cost = $0.10125m ie same as above

Therefore overall interest payment= $(0.10125+0.17125)m

= $0.2725m

3rd QUARTER:

LIBOR turns out to be 3.5%*90/360 = 0.8750%

Therefore, interest payment to bank= 0.8750+0.90%=1.775%

Projected interest payment to bank = $10m*1.1775%

= $0.1775m

Net swap payment = Giving 3.5% and getting 3.15%

ie net payment =$10m * 0.35%*90/360

= $ 0.00875m

Effective cost = $0.10125m same as above

Therefore , overall interest payment =$(0.1775+0.10125)m

= $ 0.27875m

4th QUARTER:

LIBOR turns to be 3.6%*90/360=0.9%

Therefore interest payment to the bank = 0.9+0.9%=0.18%

Projected interest payment to bank = $10m*0.18%

= $0.018m

Net swap payment = giving 3.6% and getting 3.15%

ie net payment = $10m*0.45%*90/360

= $0.01125m

Effective cost = $0.10125m same as above

Therefore overall net interest payment = $(0.18+0.10125)m

= $0.28125m