Consider bank that has entered into a five-year swap on a notational balance of $10,000,000 with a corporate customer who has agreed to pay a fixed payment of 10 percent in exchange for LIBOR. As of the fourth reset date, determine the price of the swap from the bank's point of view assuming that the fixed-rate side of the swap has increased to 11 percent. LIBOR is at 5 percent.
A)$909,090.91 gain.
B)$90,090.09 loss.
C)No loss or no gain since maturity has not arrived.
D)$90,090.09 gain.

Question

Quizplus · Accepted Answer

In a swap, each leg is valued separately. In this case, the bank receives the floating rate, while it pays the fixed rate. Therefore, the value of the swap for the bank can be calculated as:

Value of Fixed Leg = (Fixed Rate - Current Fixed Rate) x Notional Amount x (Time to Next Payment Date / 360)

= (0.11 - 0.1) x $10,000,000 x (90 / 360)

= $27,777.78

Value of Floating Leg = (Current Floating Rate - Previous Floating Rate) x Notional Amount x (Time to Next Payment Date / 360)

= (0.05 - 0.05) x $10,000,000 x (90 / 360)

= $0

Total Value of Swap for Bank = Value of Fixed Leg - Value of Floating Leg

= $27,777.78 - $0

= $27,777.78 (loss)

Therefore, the correct answer is B, a loss of $90,090.09 from the bank's point of view.

Consider Bank That Has Entered into a Five-Year Swap on a Notational