CFA Practice Question

CFA Practice Question

Counterparties A and B have entered into a 3-year plain vanilla interest rate swap today. The swap has a notional principal of $100 million and resets every 3 months. A pays fixed rate of 8% while B pays the floating rate of 3-month LIBOR + 60 basis points. The current 3-month LIBOR rate equals 7.4%. If the 3-month LIBOR rate on the first and second swap reset dates equal 7.5% and 7.8%, which of the following is (are) true?

I. No money exchanges hand today.
II. In 3 months, A pays B an amount of $50,000.
III. In 6 months, B pays A an amount of $33,333.
A. I and II.
B. I and III.
C. I only.
Explanation: No money changes hand today.

On the first reset date, A's liability is 8% and that of B is 7.4% + 60 basis points = 8%, both on an annualized basis. Thus, the two payments cancel out and no money exchanges hand on the first reset date.

On the second reset date, A's liability is 8% and that of B is 7.5% + 60 basis points = 8.1%, both on an annualized basis.

The net difference of 10 basis points annualized equals 2.5 basis points and means that B pays A an amount equal to $2.5*0.0001*100 million = $25,000.

User Contributed Comments 4

User Comment
Janey Only in a currency swap is a notional exchanged upfront
Bparsons Paid in arrears
thebkr7 I may be mistaken as I often am, but did the question get the first reset day mixed up with the second?
connor15 thebkr7: the question is correct. You use the current 3-month LIBOR rate, 7.4%, as the first SWAP reset date rate, and use the rate on the first reset date, 7.5%, as the second reset date.
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