The Bank of Moronto has negotiated a plain vanilla swap in which it will exchange fixed payments of 10 percent for floating payments equal to LIBOR plus 0.5 percent at the end of each of the next three years. In the first year, LIBOR is 8 percent; in the second year, 9 percent; in the third year, LIBOR is 7 percent. What is the total net payment the Bank of Moronto makes over the three-year period if the notional principal is $10 million?

Question

Quizplus · Accepted Answer

To calculate the total net payment, we need to calculate the fixed payments and the floating payments for each year and take the difference.

Fixed payments = 10% of notional principal = 10% * $10 million = $1 million

Year 1:
Floating payments = LIBOR + 0.5% = 8% + 0.5% = 8.5%
Net Payment = Fixed Payment - Floating Payment = $1 million - $850,000 = $150,000

Year 2:
Floating payments = LIBOR + 0.5% = 9% + 0.5% = 9.5%
Net Payment = Fixed Payment - Floating Payment = $1 million - $950,000 = $50,000

Year 3:
Floating payments = LIBOR + 0.5% = 7% + 0.5% = 7.5%
Net Payment = Fixed Payment - Floating Payment = $1 million - $750,000 = $250,000

Total net payment = $150,000 + $50,000 + $250,000 = $450,000

Therefore, the answer is D, $450,000.

The Bank of Moronto Has Negotiated a Plain Vanilla Swap