Toret Ltd. has an outstanding $100,000,000 loan that matures in four years. The interest rate on the loan is LIBOR and is payable at the end of each year. Toret would like to hedge against an increase in interest rates. Toret enters into a swap that would allow them to pay a fixed rate of 7% and receive LIBOR. There is also a swaption available with an exercise rate of 7.5%. The swaption is European style and Toret will consider unwinding the swap at the first settlement date. If Toret does exercise the swaption, it will enter into the swap.
What would be the net cash flows on the first settlement date if the fixed rate on the underlying swap is 6.5% and LIBOR is 5.75%?
What would be the net cash flows on the first settlement date if the fixed rate on the underlying swap is 6.5% and LIBOR is 5.75%?