### CFA Practice Question

There are 206 practice questions for this study session.

### CFA Practice Question

Two parties enter into a three-year interest rate swap, which involves the exchange of LIBOR+1% for a fixed rate of 12% on a \$100 million notional amount. The LIBOR rate today is 11%, but is expected to increase to 15% in one year and then fall back down to 8%. Which statement accurately depicts the flow of net cash flows between the two counter-parties?
A. The variable rate payer would receive a payment of \$4 million at the end of year two, while the fixed rate payer would receive \$3 million at the end of year three.
B. The fixed rate payer would receive a payment of \$4 million at the end of year two, while the variable rate payer would receive \$3 million at the end of year three.
C. The fixed rate payer would have to pay \$3 million at the end of the second year and \$3 million at the end of the third year.
Explanation: With a variable of LIBOR + 1%, the effective interest payment for the variable rate payer will be 12% in year one, 16% in year two, and 9% in year three.

End of year 1: fixed pays (\$100million * 12%): \$12 million; Variable pays (\$100million * 12%): \$12 million. Net cash flow received by fixed payer: NIL.

End of year 2: fixed pays (\$100million * 12%): \$12 million; Variable pays (\$100million * 16%): \$16 million. Net cash flow received by fixed payer: \$4 million.

End of year 3: fixed pays (\$100million * 12%): \$12 million; Variable pays (\$100million * 9%): \$9 million. Net cash flow received by variable payer: \$3 million.