Question

c. Because its financial position has strengthened considerably very recently, Apache Airlines is offered an interest rate swap-fixed to floating (LIBOR). The details are as follows: Current Apache bond maturity - 10 years Bond face value - $200M Current bond rate - 6% per year, fixed Floating rate - LIBOR + 100 basis points Projected LIBOR rates: 4.5% (years 1-2),5% (years 3-4), 5.5% (years 5-6),5% (years 7-10) Show the cash flows for Apache and the present value gain/loss of doing the swap.

			Cash Flows
Bond outstanding			Original	Swap Pmts.	Net
Maturity (yrs.)		Year 1
Fixed rate		Year 2
Spread over LIBOR		Year 3
LIBOR:		Year 4
Years 1-2		Year 5
Years 3-4		Year 6
Years 5-6		Year 7
Years 7-10		Year 8
		Year 9
		Year 10
			Present value of net

Answer 1

Answer.

No Required rate of return given for Apache, Hence it is assumed Apache can invest gains at 6%

			CashFlows
Bond outstanding	200		Original	Swap Pmts.	Net	DF	PV
Maturity (yrs.)	10	Year 1	12	11	1	0.943	0.943
Fixed rate	6	Year 2	12	11	1	0.890	0.890
Spread over LIBOR	100	Year 3	12	12	0
LIBOR:		Year 4	12	12	0
Years 1-2	4.5	Year 5	12	13	-1	0.747	-0.747
Years 3-4	5	Year 6	12	13	-1	0.705	-0.705
Years 5-6	5.5	Year 7	12	12	0
Years 7-10	5	Year 8	12	12	0
		Year 9	12	12	0
		Year 10	12	12	0
			Present value of net				0.381