###
**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?

II. In 3 months, A pays B an amount of $50,000.

III. In 6 months, B pays A an amount of $33,333.

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. |