EXERCISE QUESTION ON SWAP Remarks: Try to use your Excel Goal Seek function...
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EXERCISE QUESTION ON SWAP
Remarks: Try to use your Excel Goal Seek function as well as solving it through your manual calculation.
A commercial bank is contemplating an interest rate swap into a floating rate every three months for a period of 1 year on the notional principal of $100 million borrowed earlier at 3% on a fixed-rate basis. The bank follows the most simplistic 30/360 day count convention. The bank today can borrow money on a floating rate basis at the 3-month LIBOR plus 10 basis points. However, the LIBOR fluctuates. The future 3-month LIBOR is estimated as the forward rates implicit in the 3-month CD futures. The Euro dollar 3-month CD futures are quoted as follows today.
Maturity
Euro Dollar CD Futures Price
3 months
97.85
6 months
97.45
9 months
97.28
1 year
97.10
(1)Given that the current CD futures prices, are they paying too much? Compute the optimal LIBOR-based floating rate for the bank?
(2)Now 6 months into the swap, 3-month LIBOR CD futures are repriced as follows. Compute the value of the swap.
Period
Euro Dollar CD Futures Price
3 months
97.27
6 months
97.00
Answer & Explanation
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