Hi guys, I have confusion on this problem :
A company borrows $15 million from a bank for one year at LIBOR, currently at 4.75%, plus 50 basis points. At the same time, the company enters a one-year, plain vanilla interest rate swap to pay the fixed rate of 5.25% and receive LIBOR. Payments are made on the basis of 180 days in the settlement period. Floating payments are made on the basis of 360 days in a year, and fixed payments are made on the basis of 365 days in a year. LIBOR is 5.00% on the first settlement date. The company’s total interest expense for the loan and the swap for the first settlement period is closest to:
I understand that the fixed amount would be ($15,000,000)(0.0525)(180/365) = $388,356
What should be the floating amount?
The correct answer is $425,856.
Thanks for your help
The floating rate on a swap is set in advance and paid in arrears. Here, the LIBOR rate is set at time 0 (inception of the swap) at 4.75% and paid at time 1 (180 days after inception). Thus, the net payment on the swap is (5.25% – 4.75%)*(180/360)*$15,000,000 = $37,500 paid by the company.
Thannks but it also says that LIBOR is 5% on the first settlement day, so it should be 5% - 4.75%? where am i wrong here. please suggest
Reread what I wrote: _ the floating rate on a swap is set in advance and paid in arrears _: the LIBOR rate on the first payment date will be used to calculate the payment on the _ second _ payment date; the LIBOR rate at inception will be used to calculate the payment on the _ first _ payment date.
I think the equation in the notes is quit nice.
I used to calculate like this, but to save brain power, which I think I will need in the test, I just use the equation.