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EXERCISE QUESTION ON SWAP Remarks: Try to use your Excel Goal Seek function...

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Accounting

EXERCISE QUESTION ON SWAP

Remarks: Try to use your Excel Goal Seek function as well as solving it through your manual calculation.

A commercial bank is contemplating an interest rate swap into a floating rate every three months for a period of 1 year on the notional principal of $100 million borrowed earlier at 3% on a fixed-rate basis. The bank follows the most simplistic 30/360 day count convention. The bank today can borrow money on a floating rate basis at the 3-month LIBOR plus 10 basis points. However, the LIBOR fluctuates. The future 3-month LIBOR is estimated as the forward rates implicit in the 3-month CD futures. The Euro dollar 3-month CD futures are quoted as follows today.

Maturity

Euro Dollar CD Futures Price

3 months

97.85

6 months

97.45

9 months

97.28

1 year

97.10

(1) Given that the current CD futures prices, are they paying too much? Compute the optimal LIBOR-based floating rate for the bank?

(2) Now 6 months into the swap, 3-month LIBOR CD futures are repriced as follows. Compute the value of the swap.

Period

Euro Dollar CD Futures Price

3 months

97.27

6 months

97.00

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