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Answer: USD 125,000
## Explanation **C is correct.** The company is hedging against rising interest rates, which means the company wants to pay at the fixed rate and receive the floating rate. ### Calculation: - **Cash flow formula:** Cash flowᵢ = notional × (floating rateᵢ - fixed rate) × length of period - **Notional:** USD 100,000,000 - **Fixed rate:** 2.75% (annual) - **Floating rate for Year 2 (July-Dec):** 2.70% + 30 bps = 2.70% + 0.30% = 3.00% - **Length of period:** 0.5 years (semi-annual payments) **Cash flow at end of year 2:** = 100,000,000 × (3.00% - 2.75%) × 0.5 = 100,000,000 × (0.0025) × 0.5 = 100,000,000 × 0.00125 = USD 125,000 ### Why other options are incorrect: - **A:** This would be the cash flow if the company pays floating and receives fixed (opposite position) - **B:** This omits the 30 bps spread from the floating rate calculations - **D:** This appears to be the sum of net cash flows over 2 years rather than just the Year 2 payment Since the company is hedging against rising rates, they want to receive the floating rate (which increases with rising rates) and pay the fixed rate (which remains constant). The positive cash flow of USD 125,000 represents the net amount the company receives when the floating rate exceeds the fixed rate.
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The treasurer of a large manufacturing company has decided to hedge against rising interest rates. The treasurer wants to enter into a 2-year fixed-for-floating swap with a notional of USD 100 million, a fixed annual interest rate of 2.75%, semi-annual payments, and a floating interest rate of 6-month SOFR plus 30 bps, starting in January of Year 1. The treasurer uses the following forecast of future 6-month SOFR rates:
| Time period | Rate |
|---|---|
| Jan-Jun Year 1 | 2.40% |
| July-Dec Year 1 | 2.57% |
| Jan-Jun Year 2 | 2.66% |
| July-Dec Year 2 | 2.70% |
Which of the following is the best estimate of the net cash flow that the treasurer expects for the company to receive at the end of year 2?
A
USD –125,000
B
USD –25,000
C
USD 125,000
D
USD 265,000
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