A thrift has funded 10 percent fixed-rate assets with variable-rate liabilities at LIBOR + 2 (L + 2) percent.A bank has funded variable-rate assets with fixed-rate liabilities at 6 percent.The bank's variable-rate assets earn LIBOR + 1 (L + 1) percent.The thrift and the bank have reached agreement on an interest-rate swap with the fixed-rate swap payment at 6 percent and the variable-rate swap payment at LIBOR. Assume that the swap is for two years and that LIBOR is 5.25 percent in year one and 6.25 percent in year two.What will be the net swap cash flow each year if the notional value of a swap is $100 million?
A)The thrift pays $0.75 million to the bank in year one and receives $0.25 million from the bank in year two.
B)The thrift receives $0.75 million from the bank in year one and pays $0.25 million to the bank in year two.
C)The thrift pays $0.25 million to the bank in year one and receives $0.75 million from the bank in year two.
D)The thrift receives $0.25 million from the bank in year one and pays $0.75 million to the bank in year two.
E)None of the options.

Question

Quizplus · Accepted Answer

In year one, the thrift effectively pays 6% (fixed-rate swap payment) and receives LIBOR (5.25%), resulting in a net payment of 0.75% of the notional value ($100 million), which equals $0.75 million to the bank. In year two, the thrift pays 6% but receives a higher LIBOR (6.25%), leading to a net receipt of 0.25% of the notional value, or $0.25 million from the bank.

A Thrift Has Funded 10 Percent Fixed-Rate Assets with Variable-Rate