On January 1,2014,Panther Company received a two-year $600,000 loan.The loan calls for payments to made at the end of each year based on the prevailing market rate at January 1 of each year.The interest rate at January 1,2014,was 10 percent.Aegean company also has a two-year $600,000 loan,but Aegean's loan carries a fixed interest rate of 10 percent.
-Panther Company does not want to bear the risk that interest rates may increase in year two of the loan.Aegean Company believes that rates may decrease and they would prefer to have variable debt.So the two companies enter into an interest rate swap agreement whereby Aegean agrees to make Panther's interest payment in 2015 and Panther likewise agrees to make Aegean's interest payment in 2015.The two companies agree to make settlement payments,for the difference only,on December 31,2015.If the interest rate on January 1,2015,is 12 percent,what will be Panther's settlement payment to/from Aegean?

Question

Quizplus · Accepted Answer

Panther Company's loan has a variable interest rate, which means that the interest payment in 2015 will be calculated based on the prevailing market rate at January 1, 2015. Since the interest rate at January 1, 2015, is 12 percent, Panther Company will have to pay 12% * $600,000 = $72,000 in interest in 2015.

However, Panther Company has entered into an interest rate swap agreement with Aegean Company. Under this agreement, Aegean Company will make Panther's interest payment in 2015. This means that Panther will not have to make the interest payment of $72,000 to its lender. Instead, it will make a settlement payment to Aegean Company, reflecting the difference between the fixed interest rate of 10% and the variable interest rate of 12%.

The settlement payment will be calculated as follows:

Settlement payment = (Fixed rate - Variable rate) * Notional amount
                   = (10% - 12%) * $600,000
                   = -$12,000

A negative settlement payment means that Panther Company will receive $12,000 from Aegean Company. Therefore, the answer is D) $12,000 receipt.

On January 1,2014,Panther Company Received a Two-Year $600,000 Loan