Explanation:
Savers Bank will pay $25,000 to Moon Traders on September 30, 2016. On the other hand, Moon Traders will pay $2.475 million to Savers Bank.
Savers Bank's cash outflow = (5%/2) × $100 million = −$2.5 million
Savers Bank's cash inflow = (4.95%/2) × $100 million = $2.475 million
Net cash flow on September 30, 2016 = $2,475,000 − $2,500,000 = −$25,000
One crucial element of plain vanilla swaps is that the exchange of funds related to a particular LIBOR (floating rate) takes place one period (six months in the case of our example) after the LIBOR rate is observed. In other words, at the beginning of each period, both payments for the end of the period—fixed and floating—are known. This allows both parties to budget for their future payments.
Q.709 Kevin Bernard, the head of the derivatives trading department at Savers Bank, entered into a 3-year swap agreement on September 30, 2015, with Moon Traders. In the agreement, Savers Bank agreed to pay Moon Traders an interest rate of 5%, paid semiannually on the principal of $100 million. In return, Moon Traders agreed to pay Savers the LIBOR rate on the same principal. If the LIBOR prevailing on March 30, 2016, is 4.95% paid semiannually, which of the following statements is true?
A
Savers Bank will pay $25,000 to Moon Traders on March 30, 2016.
B
Savers Bank will receive $25,000 from Moon Traders on March 30, 2016.
C
Savers Bank will pay $25,000 to Moon Traders on September 30, 2016.
D
Savers Bank will receive $25,000 from Moon Traders on September 30, 2016.
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