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Sir,
(1)
In requirement a(ii) answer
they have calculated “Receive yield – 20 bp” as ($400m * (2.9%-0.2%))=$10.80m
My question is why did they used 2.9% when in the case it was said that, “In return, Pault Co would receive from Millbridge Bank a variable amount based on the forward rates calculated from the annual spot yield curve rate at the time of payment”???
(2)
What will happen if in the question requirement a(ii) it was written that Calculate Pault Co’s interest payment liability for “Year 2” if the yield curve rate is 4.5% or 2.9%. ( instead of year 1 it is year 2 and explain me only “Receive yield – 20 bp” and this is only for my understanding to clear my concept, Please show calculation so that i can understand more clearly)
The question specifically asks for the calculation if the yield curve rate is 4.5% or 2.9%
The receipt from Millbridge is the yield curve rate minus 20 basis points, so if the yield curve rate is 2.9% then they will receive 2.7% (which on 400M is 10.80M.
If the question had asked for the second year, then the interest would be exactly the same.
Sir,
Hope all is well.
I would like to use this thread to add a question regarding a) i) and ii)
I understand the calculation and I understand that in ii) the point is to get a fixed rate to eliminate the risk from the interest rate to go too high.
But if I just read the questions as I did first, I was ok looking at i) because we calculated the swap by:
– Yearly interest payment based on the fixed rate
– Yearly interest receivable based on the yearly yield curve rate that is changing every year (and as we see, we pay more in first 2 years and then gain the years afterBut when moving to ii), I dont understand why we suddenly pay the fixed rate but also the floating rate (+0.5) and the receivable of the floating rate (-0.2)
Yes it is to get a new fixed rate to remove the risk.
But by reading the questions, I dont understand why we did that in ii) but we did not do that in i)
why in the first part (i), we dont also include then the 2nd payment based on the floating rate (+0.5)?(a) (i) Is asking you to use the current yield rates as estimate of the forward rates and to calculate the net receipt or payment in each of the years.
(a) (ii) is asking you to illustrate what happens in the first year of the swap and is as I explain in my free lectures – showing that the new result will be the same whatever happens to the yield.
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