Swap Question

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Sp3c

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HI everyone, just seeking help on this question. I do not understand why a Libor of 4.75% was used for the floating rate payment instead of the 5.00%. Any thoughts would be appreciated.
A company borrows $15 million from a bank for one year at LIBOR, currently at 4.75%, plus 50 basis points. At the same time, the company enters a one-year, plain vanilla interest rate swap to pay the fixed rate of 5.25% and receive LIBOR. Payments are made on the basis of 180 days in the settlement period. Floating payments are made on the basis of 360 days in a year, and fixed payments are made on the basis of 365 days in a year. LIBOR is 5.00% on the first settlement date. The company’s total interest expense for the loan and the swap for the first settlement period is closest to:
$388,356.
$444,606.
$425,856.
The company pays the swap dealer the fixed rate of 5.25%, pays the bank LIBOR of 4.75% (as set at the beginning of the period) plus 0.50%, and receives LIBOR from the swap dealer.
Fixed payment: ($15,000,000)(0.0525)(180/365) = $388,356
Floating payment: ($15,000,000)(0.0475 + 0.005 – 0.0475)(180/360) = $37,500
Net interest expense: $425,856
 
Floating rates are established (set) in advance and paid – as tareq wrote – in arrears.
The floating rate is set at the beginning of the payment period; here, the LIBOR rate at the beginning of the first payment period is 4.75%, so that’s the rate used for the first payment, which is made at the end of the first period.
 
Ok thanks guys. But why would the Company enter into such an agreement..they are just giving away the 50 basis points in interest. Or this is just a weird type of question?
 
Oh so they are betting that LIBOR will be above 5.25% in the second half of the year of the agreement?
 
Let me get this straight.
At settlement, the interest you use for a SWAP is from when the rate was previously set.
For an FRA at expiration/settlement, you use the rate at that period becaues it is “technically” paid the next period but since it settles at expiration, you discount it back to the current period.
 
blackscholesvol wrote:Let me get this straight.
At settlement, the interest you use for a SWAP is from when the rate was previously set.
For an FRA at expiration/settlement, you use the rate at that period becaues it is “technically” paid the next period but since it settles at expiration, you discount it back to the current period.
Click to expand...
Yup and yup.
 
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