Goldman Sachs and Alphabet agree on an interest rate swap on October 3, 2019 on...
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Goldman Sachs and Alphabet agree on an interest rate swap on October 3, 2019 on a notional principal of $300 million. Goldman will make annual floating payments according to the 1-year LIBOR plus 1%. Alphabet in return will make fixed-rate payments on annual basis. The first cash flow exchange will occur on October 3, 2020. The contract will last for a period of 3 years. On October 3, 2019, the following LIBOR zero rates and continuously compounded risk-free interest rates are as follows:
| Maturity | LIBOR Zero Rate (%) | Risk-free Rate (%) |
| 1 year | 2.75 | 2.00 |
| 2 years | 3.25 | 2.00 |
| 3 years | 3.50 | 2.00 |
- If there is no cash settlement at the initiation of the contract, what should be the fair fixed rate that Alphabet should pay?
- If Alphabet prefers a fixed rate of 4% annually, what cash settlement is needed between the parties on October 3, 2019 in order to have a fair contract?
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