DWR Services, Ltd., arranges a plain vanilla interest rate swap between RWDY Enterprises (pays fixed) and RED, Inc. (receives fixed). The swap has a notional value of $25,000,000 and 270 days between payments. LIBOR is currently at 7.0%. If at the time of the next payment (due in exactly 270 days), RWDY receives net payments of $93,750, the swap fixed rate is closest to: A) 6.625%. B) 7.500%. C) 6.500%. D) 7.375%. tough one I thought, I was way off track
if they receive 93,750 for 270 days, it would equate to an anual 125,000 (x 360 / 270). This equals 0.5% (125,000 / 25,000,000) This is the difference between the fixed and variable payments. Therefore, since RDWY receives net 0.5%, their interest rate was 6.5% (7% - 0.5%) ? So C?
good work, correct The answer used this formula -Fixed Rate Payment = (Fixed rate - LIBOR)*(270/360)*Principal and then solved for the fixed Rate.
RWDY = pay fixed- receive floating RED = receive fixed - pay floating If RWDY receives the payment…how do you know that the interest rate is (7 - 0.5)? and not (7+ 0.5) ?
because “RDWY receives net $93,750” (0.5%), therefore, the interest rate they were paying must have been less than the interest rate they were being paid by a net 0.5%
that’s true… but i always find the “Pay fixed” a little counter intuitive. like RWDY ‘pay-fixed’ meaning that they always pay the fixed rate at 7% (in the example). Therefore, if interest rates was 6.5 % RWDY will still have to pay the 0.5% difference to RED and if it was at 7.5%, RWDY will receive the 0.5% payment?
As Stalla aways says, draw the diagram! The facts you are given are: RWDY Enterprises (pays fixed) RED, Inc. (receives fixed). LIBOR is currently at 7.0% RWDY receives net payments of $93,750 (0.5%) RWDY Enterprises (pays fixed) --------------------------------> So pays “fixed + 0.5%” = 7%
newsuper Wrote: ------------------------------------------------------- > DWR Services, Ltd., arranges a plain vanilla > interest rate swap between RWDY Enterprises (pays > fixed) and RED, Inc. (receives fixed). The swap > has a notional value of $25,000,000 and 270 days > between payments. LIBOR is currently at 7.0%. If > at the time of the next payment (due in exactly > 270 days), RWDY receives net payments of $93,750, > the swap fixed rate is closest to: > > A) 6.625%. > > B) 7.500%. > > C) 6.500%. > > D) 7.375%. > > > tough one I thought, I was way off track 93750 *360/270 = 125000 Now 125000/25000000 = .005 or .5% or the difference between Fixed and Floating. Thus the rate is 6.5 or C. Dont get this equation mixed up w/ FRA equation which is Po[(Floating-fixed)*(days/360)/(1+floating)*(days/360)] The equaton need here is (Fixed-Floating)*Notational*days/360
Just to get an undeerstanding of drawing the diagram the other way round: Say, RWDY Enterprises (pays fixed) RED, Inc. (receives fixed). LIBOR is currently at 7.0% but now RED receives net payments of $93,750 (0.5%) RWDY Enterprises (pays fixed) -------------------------> pays fixed receives 7% + 0.5%
to be honest, we’re probably over complicating it. LIBOR (variable) is clearly 7% (it says so in the question). Fixed must be 0.5% less than variable since the fixed payer is receiving a 0.5% profit.
Youre right… thanks