# Struggling with CFAI EOC Swaps Questions

I’m really struggling with these EOC Swap questions. There are a couple questions that I have NO idea where the number is coming from by looking at the answers.

Question 3B

In the question, A company issues a leveraged floating-rate note with a face value of \$5,000,000 that pays a coupon of 2.5 times Libor

I don’t understand, why do we have to multiply face value 5,000,000 by 2.5? I though 2.5 times just refers to the coupon

Question 9B

A company plans to borrow \$20,000,000 in two years. The loan will be for three years and pay a floating interest rate of Libor with interest payments made every quarter. The company expects interest rates to rise in future years and thus is certain to swap the loan into a fixed-rate loan. In order to ensure that it can lock in an attractive rate, the company plans to purchase a payer swaption expiring in two years, with an exercise rate of 5 percent a year. The cost of the swaption is \$250,000, and the settlement dates coincide with the interest payment dates for the original loan. Assume Libor at the beginning of the settlement period is 6.5 percent a year.

1. B

Calculate the net cash flows on the first settlement date if FS(2,5) is below the exercise rate.

Answer: If FS(2,5) is below the exercise rate, it will not be worth exercising the swaption. However, the company can enter a three-year swap to pay a fixed rate of 4 percent, for example, and receive Libor of 6.5 percent. Swap payments on first quarterly settlement date: Pay \$20,000,000(90/360)(0.04) = \$200,000 Receive \$20,000,000(90/360)(0.065) = \$325,000 Loan payment = \$20,000,000(90/360)(0.065) = \$325,000 Net cash flow = –\$200,000 I’m completely confused: Where is 4% coming from?

If FS(2,5) is below the exercise rate, it will not be worth exercising the swaption. However, the company can enter a three-year swap to pay a fixed rate of 4 percent

Right, that’s what the answer says, but I’m not seeing the 4% anywhere in the question?

it says below exercise - and says 4% for example… 4% is below 5% (the exercise rate). It is an example number.

Urrrrr…I didn’t know that we can just pick a number and do the calculation for a case like this. Screw me, what a GREAT question! Thanks CPK.