I’m really struggling with these EOC Swap questions. There are a couple questions that I have NO idea where the number is coming from by looking at the answers.
Question 3B
In the question, A company issues a leveraged floating-rate note with a face value of $5,000,000 that pays a coupon of 2.5 times Libor
Answer: Buy bonds with a face value = 2.5*$5,000,000=$12,500,000
I don’t understand, why do we have to multiply face value 5,000,000 by 2.5? I though 2.5 times just refers to the coupon
Question 9B
A company plans to borrow $20,000,000 in two years. The loan will be for three years and pay a floating interest rate of Libor with interest payments made every quarter. The company expects interest rates to rise in future years and thus is certain to swap the loan into a fixed-rate loan. In order to ensure that it can lock in an attractive rate, the company plans to purchase a payer swaption expiring in two years, with an exercise rate of 5 percent a year. The cost of the swaption is $250,000, and the settlement dates coincide with the interest payment dates for the original loan. Assume Libor at the beginning of the settlement period is 6.5 percent a year.
Answer:
If FS(2,5) is below the exercise rate, it will not be worth exercising the swaption. However, the company can enter a three-year swap to pay a fixed rate of 4 percent, for example, and receive Libor of 6.5 percent.
Swap payments on first quarterly settlement date:
Pay $20,000,000(90/360)(0.04) = $200,000
Receive $20,000,000(90/360)(0.065) = $325,000
Loan payment = $20,000,000(90/360)(0.065) = $325,000
Net cash flow = –$200,000
I’m completely confused: Where is 4% coming from?
Question 3B
In the question, A company issues a leveraged floating-rate note with a face value of $5,000,000 that pays a coupon of 2.5 times Libor
Answer: Buy bonds with a face value = 2.5*$5,000,000=$12,500,000
I don’t understand, why do we have to multiply face value 5,000,000 by 2.5? I though 2.5 times just refers to the coupon
Question 9B
A company plans to borrow $20,000,000 in two years. The loan will be for three years and pay a floating interest rate of Libor with interest payments made every quarter. The company expects interest rates to rise in future years and thus is certain to swap the loan into a fixed-rate loan. In order to ensure that it can lock in an attractive rate, the company plans to purchase a payer swaption expiring in two years, with an exercise rate of 5 percent a year. The cost of the swaption is $250,000, and the settlement dates coincide with the interest payment dates for the original loan. Assume Libor at the beginning of the settlement period is 6.5 percent a year.
- B
Answer:
If FS(2,5) is below the exercise rate, it will not be worth exercising the swaption. However, the company can enter a three-year swap to pay a fixed rate of 4 percent, for example, and receive Libor of 6.5 percent.
Swap payments on first quarterly settlement date:
Pay $20,000,000(90/360)(0.04) = $200,000
Receive $20,000,000(90/360)(0.065) = $325,000
Loan payment = $20,000,000(90/360)(0.065) = $325,000
Net cash flow = –$200,000
I’m completely confused: Where is 4% coming from?