a) ABC Ltd is interested to sell an existing fixed-for-floating interest rate swap to one of its corporate clients. Under the existing swap, ABC Ltd pays 10% pa and receive 3-month LIBOR on a $10 million principal. Cash flows are exchanged every quarter. The swap has a remaining life of 16 months. Data shows that the 3-month LIBOR rate 1 month ago was 11.8% pa; 2 months’ ago it was 12% pa; 3 months’ ago it was 12.2% pa and 4 months’ ago it was 12.3% pa. The relevant discount rate is 12% per annum for all maturities. All rates are compounded quarterly. What is the value of the swap?
b) Will ABC Ltd be receiving or paying the value of the swap in (a)? Elaborate.
The ABC Ltd is paying at 10%pa on $10 million principal.
i.e. $10 m*10%= $1 m per year and $ 8,333 per month
and have received
4 months ago | 12.3% | 10,250 |
3 months ago | 12.2% | 10,167 |
2 months ago | 12.0% | 10,000 |
1 month ago | 11.8% | 9,833 |
Total amount | 40,250 |
for the Last 4 months
It pays $33,333 and received $ 40,250
a) Total benefit at present from past cash flow = $6,916.67
b) ABC Ltd will be receiving the value of swap in (a) because it is paying at 10% pa and received more on LIBOR
Suppose it receives 11.5% pa on LIBOR for rest of 16 months(as no rates are mention so assume at 11.5% from the past trend)
the PV of cash flow will be as follows
month | interest amt | PV of CF |
1 | 9583 | 9488 |
2 | 9583 | 9394 |
3 | 9583 | 9301 |
4 | 9583 | 9209 |
5 | 9583 | 9118 |
6 | 9583 | 9027 |
7 | 9583 | 8938 |
8 | 9583 | 8849 |
9 | 9583 | 8762 |
10 | 9583 | 8675 |
11 | 9583 | 8589 |
12 | 9583 | 8504 |
13 | 9583 | 8420 |
14 | 9583 | 8336 |
15 | 9583 | 8254 |
16 | 9583 | 8172 |
1,41,036 |
and will pay in future at compounded rate of 10% pa for 16 months
i.e. total = 1000000(1+0.0083)16 = 1141395
Interest paid = 141395
PV of interest Paid = 120585
Net amount received in SWAP = 141036-120585 = $20,451
P
a) ABC Ltd is interested to sell an existing fixed-for-floating interest rate swap to one of...
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