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 December 31,2014 is 12 percent,what amount will Panther report as the fair value of the interest rate swap at December 31,2014 (answers rounded to the nearest dollar)?

Question

Quizplus · Accepted Answer

The fair value of an interest rate swap is determined by calculating the present value of the future cash flows that will result from the swap agreement. In this case, Panther Company will receive interest at 10% on its $600,000 loan in 2015, but Aegean Company will make the payment on its behalf. Meanwhile, Panther Company will pay interest at the prevailing market rate (12%) to Aegean Company on its $600,000 loan in 2015. Therefore, Panther Company will receive a cash inflow of $60,000 ($600,000 x 10%) from Aegean Company and pay a cash outflow of $72,000 ($600,000 x 12%) to it. The net cash flow for Panther Company is -$12,000 ($60,000 - $72,000). To calculate the fair value of the interest rate swap, we need to discount this net cash flow using the prevailing market rate at December 31, 2014 (12%). The present value of -$12,000 using a discount rate of 12% is -$10,715. Therefore, Panther Company would report a fair value of -$10,715 for the interest rate swap at December 31, 2014.

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