Problem:
As an assistant treasurer of a large corporation, your job is to look for ways your company can lock in its cost of borrowing in the financial market. The date is July 31. Your firm is taking out a loan of $200 million, with an annual interest rate of prime plus 5 percent and a maturity of 5 years. The current prime rate is 5 percent. You recommend that the firm engage in interest rate swap contract with SWAP Bank. According to the swap contract with the notional principal amount of $200 million, you should pay 5.4 percent fixed-rate to SWAP Bank and in return, receive prime rate from SWAP Bank. Payments are made every year (at the end of each year). If the prime rate at the end of 1st, 2nd, 3rd, 4th, and 5th year turns out 6%, 6.5%, 7%, 7%, and 6.8%, respectively, what should be the effective interest payment (i.e. interest payment on $200 million loan plus net payment from interest rate swap contract) at the end of 2nd year?