Question

An Italian company, New Century Corp, enters into a 1-year interest rate swap with Northern European Bank. The notional principle of the swap is €100 million. Payments will be made semiannually on the basis of 180/360 (180 days in the settlement period and 360 days per year). New Century will pay a fixed rate of 4% and receive floating rate Euribor plus 1%. The 180-day Euribor rates are as below:
Current: 2.8%       In 1 quarter: 3%   In 2 quarters: 3.4%   In 3 quarters: 3.7%
A. Determine the initial exchange of cash that occurs at the start of the swap.
B. Determine the semiannual payments for the first year (first half, second half).  
C. Determine the final exchange of cash that occurs at the end of the swap.

Answer 1

A. There will be no initial exchange of cash as it is an interest swap. Currency swaps involve exchange of cash at swap initiation.

B. First half interest payment:

Notional principle*interest rate*180/360

Interest to be paid by New century corp = 100,000,000*0.04*180/360 = 100,000,000*0.02 = 2,000,000

Interest to be received by New century corp = 100,000,000*(0.03+0.01)*180/360 = 100,000,000*0.04*180/360 = 100,000,000*0.02 = 2,000,000

So, in first half there will be no payment as interest received and paid by New century corp is same.

Second half interest payment

Interest to be paid by New century corp = 100,000,000*0.04*180/360 = 100,000,000*0.02 = 2,000,000

Interest to be received by New century corp = 100,000,000*(0.037+0.01)*180/360 = 100,000,000*0.047*180/360 = 100,000,000*0.0235 = 2,350,000

New century corp will receive net interest of (2,350,000 - 2,000,000) = 350,000

C. New century corp will receive 350,000 cash at the end of the swap. however, there will no exchange of notional principle as it's an interest swap.