5.04.2005

Q&A: What are the net payment at the end of 1st year...

...for an interest rate swap agreement in which an investor has agreed to pay a dealer 8% fixed interest on a $1,000,000 notional amount ($80,000) for the next five years. In return, the dealer has agreed to pay the investor an interest rate tied to the 1 year LIBOR rate plus 1% on a notional amount of $1,000,000 for the next five years. The swap is determined in advance and paid in arrears. The 1 Year LIBOR rates for the following 2 years are shown below

Period Year 0 Year 1 Year 2
LIBOR 6.50% 6.75% 7.00%

A: the deal is obligated to pay (6.50% + 1%) * $1,000,000 = $75,000

Bonus Points

  • the LIBOR rate for year 0 is used as the swap is determined in advance.
  • The net payment is the difference between the obligations of the two counter parties.

Category: C++ Quant-Derivatives-Swaps

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