INTEREST RATE RISK

SWAP

Firm ABC enters into a swap with bank Macquarie on July 1 st for 10 mln AUD.

ABC pays fix rate of 10%, and receives Libor 3 months +50 bp.

Payments are made in arrears

Given the following rates for Libor 3 months on these dates,

 1st July: 10.25%

 1st October: 9%
 1st January: 12%
 1st April: 10.25%

Compute the settlements on 1st October, January and April, and assess who
will pay whom.

Solution:

July 1st Oct 1st Jan 1st Apr 1st

Libor 10.25% 9% 12% 10.25%

Settlement Calculation

Swap fixed rate = 10%

Swap Floating rate = Libor + 50bp (0.50%)
Assuming 3 months have 90 days
1) July:
Settlement = 10 mln *(10 – 10.75) * 90 / 36000 = 18,750
Where 10.75 = 10.25 + 0.50

Who pays whom?

ABC pays 10% and receives Libor + 50bp

On July 1st
ABC pays 10% and receives 10.75%.
Net / net ABC receives more  ABC receives the settlement of 18,750 from
Macquarie

When is the settlement paid?

On October 1st

2) October:
Settlement = 10 mln *(10 – 9.5) * 90 / 36000 = 12,500

Where 9.5 = 9 + 0.50

Who pays whom?

ABC pays 10% and receives Libor + 50bp

On October 1st
ABC pays 10% and receives 9.5%.
Net / net ABC pays more  ABC pays the settlement of 12,500 to Macquarie

When is the settlement paid?

On January 1st

3) January:
Settlement = 10 mln *(10 – 12.5) * 90 / 36000 = 62,500
Where 12.5 = 12 + 0.50

Who pays whom?

ABC pays 10% and receives Libor + 50bp

On January 1st
ABC pays 10% and receives 12.5%.
Net / net ABC receives more  ABC receives the settlement of 62,500
from Macquarie