Im having a little trouble with this question as the answers are using different rates to what I would be using. I.e. for the payment 90 days for now, they use the interest rate for LIBOR 180 days from now. What am I missing from the question? TIA
Example: Calculating the payments on an interest rate swap
Bank A enters into a $1,000,000 quarterly-pay plain vanilla interest rate swap as the fixed-rate payer at a fixed rate of 6% based on a 360-day year. The floating-ratepayer agrees to pay 90-day LIBOR plus a 1% margin; 90-day LIBOR is currently 4%.
90-day LIBOR rates are:
4.5% 90 days from now
5.0% 180 days from now
5.5% 270 days from now
6.0% 360 days from now
Calculate the amounts Bank A pays or receives 90, 270, and 360 days from now.
when dealing with LIBOR in unterest rate swaps, we use LIBOR rate of one period before because the variable rate is determined at the beginning of the settlement period, but the payment is made at the end.
As in this example,
For 90 days from now, you’ll use the current LIBOR rate i.e 4%+1%margin and fixed rate payer payes 1% to floating rate payer.
For 270 days, you’ll use LIBOR at 180 days, i.e 5%+1% margin, which equals 6%, and no payment would be made here because both have equal interest liability so they are netted.
For 360 days, you’ll use LIBOR at day 270, i.e 5.5%+1% margin, which equals 6.5%. Here the floating rate payer will pay 0.5% to the fixed rate payer.
Thanks, that makes sense. So basically the rate given for that specific time frame is determined when entering the swap? I.e. the interest rate payable in 90 days would be the current rate as that’s when we entered the position?