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Dear Sir
( JUNE 2012 – ACCA -P4 PAPER)
Question No 3 was about Interest Rate Swap. I am not understanding 3 issues
1) It is stated to calculate amounts Sembilan Co expects to pay or receive every year on the SWAP ( excluding the fee of 20 basis point. – While settling amount to be paid / received WHY 60 BASIS POINTS were ignored , as ultimately Sembilan should be paying ( Fixed 3.7625+60 basis points) – WHY THIS 60 BASIS POINTS WERE IGNORED !
2) While arriving at difference between pay / receive why SPOT RATE FOR 1ST YEAR & FORWARD RATES FOR NEXT 3 YEARS WERE USED !
3) Explain why the fixed annual rate of interest of 3.7625% is less than 4 year yield curve of 3.8% !Kindly guide me in the matter.
1 The question asks you to calculate the amount that they expect to receive and to pay if they swap. The swap offered by the bank does not mention an addition 60 basis points, which is why it has been ignored in the calculations.
2 The spot rates given are the rates quoted now for borrowing of 1, 2, 3 or 4 years. If they swap then they will receive interest based on the current rates. Although the wording is maybe a bit unclear here, it means that they will receive interest based on whatever the rate happens to be for the year. The forward rates are the best estimates available.
3 The yield curve rate for 4 years is the annual rate for borrowing for 4 years. Here they are effectively borrowing some of the money for 1 year, some for 2 years, some for 3 years and some for 4 years., and so the effective rate will be different from the yield curve rate.
Dear John Sir,
Thank you very much. You came back very fast and in crystal clear manner. Thanks once again and God bless.
Deep
Hi Sir,
in this question part (b). I am wondering why the answer use yield of 3% and 4%.
From my guess, the question ask us to DEMONSTRATE, meaning that we can just simply use different yield to show that, even the yield is different, in the end, what are we paying is fixed. Am I right?
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