Question

1. Microsoft issues a four year, floating-rate bond for the amount of $100 Million. It pays annually to bondholders. Because Microsoft would prefer to have a fixed rate payment, it enters into a SWAP with Citibank.

Year	LIBOR (%)	Fixed-Rate payments to Citibank	Floating-Rate payments from Citibank	Net payment to Citibank	Payment to bondholders	Net payment by Microsoft
1	4		4	2	3
2	5		5	1	4
3	6		6	0	5
4	7		7	-1	6

1. Explain the conditions of this SWAP

2. Which is the final fixed rate that Microsoft has to pay?

Answer 1

The amount of Bond 100M

In this transaction, as Microsoft issue a four year bond and needs to pay annually to bondholder. Microsoft wanted to make sure that the amount should be paid to bondholder so in order to cover the interest rate risk, it enters in swap transaction which shows that in every year microsft would pay fixed rate to citibank and receive floating rate payment from citibank

In this transactions, in year 1, the LIbor interest rate is 4% that means microsoft will pay 4% of 100M= 4M every year to citi bank and receive $4 as floating payment and for year 4, 7% is the libor rate where as Microsoft pays $7M to citi bank and receive $7M as floating rate and so on...