Question

Company ABC has an existing debt of 2,000,000 on which it makes annual payments at an annual effective rate of LIBOR plus 0.5%. ABC decides to enter into a swap with a notional amount of 2,000,000, on which it makes annual payments at a fixed annual effective rate of 3% in exchange for receiving annual payments at the annual effective LIBOR rate. The annual effective LIBOR rates over the first and second years of the swap contract are 2.5% and 4.0%, respectively. ABC does not make or receive any other payments. Calculate the net interest payment that ABC makes in the second year.

Answer 1

Answer:

$70,000

Explanation:

Calculation to determine the net interest payment that ABC makes in the second year

First step is to calculate interest payments on the existing debt

Interest payments on the existing debt =$2,000,000*(4.0%+.5%)

Interest payments on the existing debt =$2,000,000*4.5%

Interest payments on the existing debt =$90,000

Second step is to calculate the Fixed Payment

Fixed Payment=$2,000,000*3%

Fixed Payment=$60,000

Third step is to calculate the amount received

from swap counterparty

Amount received =$2,000,000*4%

Amount received =$80,000

Now let calculate the net interest payment

Net Interest payment=$60,000+($90,000-$80,000)

Net Interest payment=$60,000+$10,000

Net Interest payment=$70,000

Therefore the net interest payment that ABC makes in the second year is $70,000