A construction company goes to a regional bank to secure a $25 million loan to finance expansion. The bank agrees to make the quarterly loan, with a loan interest rate equal to 3-month LIBOR + 300 basis points. The company then contacts a swaps dealer and enters into an interest rate swap, agreeing to pay a fixed rate of 4.0% in exchange for receiving a floating rate of 3-month LIBOR + 300 bps. The notional principal of the swap is $25 million, and the quarterly swap’s interest payment dates are aligned with the loan’s interest payment dates. All swap payments are made quarterly and on the basis of 30 days per month and 360 days per year. At inception, 3-month LIBOR is 0.75%.
• Three months after swap inception, on the first quarterly settlement date, 3-month LIBOR is 1.20%.
• Six months after swap inception, on the second quarterly settlement date, 3-month LIBOR was 0.90%.
1. Which of the following will most likely take place on the first swap settlement date?
To settle the swap (to the nearest dollar), the construction company:
a) pays the dealer $12,500.
b) pays the dealer $15,625.
c) receives $12,500 from the dealer.
d) receives $15,625 from the dealer.
2. Which of the following will most likely take place on the second swap settlement date? To settle the swap (to the nearest dollar), the construction company:
a) pays the dealer $6,250.
b) pays the dealer $12,500.
c) receives $6,250 from the dealer.
d) receives $12,500 from the dealer.