A U.S.bank agrees to a swap of making fixed-rate interest payments of $12 million to a UK bank in exchange for floating-rate payments of LIBOR + 4 percent in British pounds for a notional amount of £100 million.The current exchange rate is $1.50/£.The interest payments will be exchanged at the end of the year at the prevailing rates. At the end of year 2, LIBOR rates are 6 percent and the exchange rate is $1.50/£.What is the net payment paid or received in dollars by the U.S.bank?
A)The U.S.bank paid $9 million and received $9 million for a net payment of $0 million.
B)The U.S.bank paid $9 million and received $15 million for a net receipt of $6 million.
C)The U.S.bank paid $12 million and received $9 million for a net payment of $3 million.
D)The U.S.bank paid $12 million and received $12 million for a net payment of $0 million.
E)The U.S.bank paid $12 million and received $15 million for a net receipt of $3 million.

Question

Quizplus · Accepted Answer

In year 1, the U.S. bank pays $12 million in fixed-rate interest to the UK bank. In exchange, it receives floating-rate payments of LIBOR+4% on a notional amount of £100 million. At the prevailing exchange rate of $1.50/£, this translates to a payment of:
LIBOR + 4% = 6% + 4% = 10%
£100 million * 10% * $1.50/£ = $15 million

So in year 1, the U.S. bank pays $12 million and receives $15 million, for a net receipt of $3 million.

In year 2, the LIBOR rate is 6% and the exchange rate is still $1.50/£. So the U.S. bank receives:
LIBOR + 4% = $6 million + 4% = $6.24 million

Converting this back to dollars using the exchange rate:
$6.24 million / $1.50/£ = £4.16 million

At the end of year 2, the U.S. bank has paid a total of $24 million in fixed-rate interest payments, but has received $15 million in floating-rate payments and £4.16 million in exchange for the swap. Converting the pound receipts back to dollars using the prevailing exchange rate, we get:
£4.16 million * $1.50/£ = $6.24 million

So the net payment received by the U.S. bank is:
$15 million + $6.24 million - $24 million = -$2.76 million
This means the U.S. bank paid $2.76 million, which is equivalent to -$2.76 million. Thus the closest answer is E) The U.S.bank paid $12 million and received $15 million for a net receipt of $3 million.

A USBank Agrees to a Swap of Making Fixed-Rate Interest Payments