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Sir for this question. I had read the article and I understood the solution. But ,I have a doubt.
My understanding of the question is like this. We took out a loan of floating rate. So to reduce the risk. We want swap.
So pay effective fixed rate to bank of 4.847 every year and bank will pay us yield -0.2 every year.
The forward rate interest is calculated from spot yield curve.
And part a calculation of w I understood.
Part b asks for interest payment liability if spoot yield curve is 2.9 or 4.5.
It’s fixed at 5.797
Bt it’s fixed at 4.847 rightWe are paying fixed at 4.847 every year.. part b .. is asking what happens if Libor becomes 2.9 or 4.5 .. over here .. I understood the workings.. but. The logic can you pls explain like isn’t it like we will pay the fixed rate..of 4.847 every year? Instead of 5.797
The 2.9 or 4.5 is it the interest that we receive from the bank?
What I interpreted is ..if Libor becomes 2.9 or 4.5 we will pay 5.797.
But my doubt is in part a it was 4.847 that was fixed rate.
Can you pls explain part b spot yield curve being 2.9 or 4.5 meaning .. does it mean it’s the rate that we have to pay?They are borrowing at floating rate and so are paying Yield + 0.5, and then they do the swap.
The swap means that they will receive Yield – 0.2 and will pay 4.847 and will pay bank charges of 0.25.So the net result is that they end up paying Y + 0.5 – (Y – 0.2) + 4.847 + 0.25 = 5.797% and this is fixed whatever happens to the yield.
The spot yield curve gives the return that investors would get on government bonds last 1 year, lasting 2 years etc.. Instead of issuing fixed rate loan notes paying a fixed rate of interest (as is usually the case) they issued loan notes where the interest changes each year depending on the yield curve rates.
So in part a.. for payment should we not multiply with 5.797 instead of 4.847?
No.
They receive from Milbridge interest based on the rates from the spot yield curve (so $14 receipt in the first year) and they pay to Milbridge interest at 4.847%.
The question says to exclude the annual fee for this point.
I would be tempted to also include the interest paid on the loan notes (and would not lose marks for having shown to much) but the question does want the receipts and payments under the swap itself.
Ok so
It’s like the company had issued floating rate loan … And that interest the company has to pay … And the interest changes each year depending on the curve.so for the company , the 5.797 is the fixed rate interest that would be paid.. if the yield goes up or down.. so this is part b of the question..
And part a of the question 4.847 was the fixed payment to the bank..
So please correct me if I am wrong..
4.847 is the fixed rate that company pays to bank every year.and 5.797 is the fixed rate that the company pays as interest of the floating rate loan to the bond holders.
Am I right? And I am sorry for asking too many questions I just could not understand that bit.. but I hope what I have said is right?Your first paragraph is correct – they end up having to pay 5.797% whatever happens to the yield.
Also 4.847% is the fixed payment to the bank.However with regard to your second paragraph, they are paying floating rate to the bond holders. But by making the swap then end result is that it is costing the company at fixed rate. (They pay floating to the bond holders bur receive floating by doing the swap – so the floating ‘cancels out’.)
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