CFA Level 1: Interest Rate Swap Agreement

Interest Rate Swap Agreement: CFA Level 1 Exam Answer

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Question

Party A enters into a plain vanilla 1-year interest rate swap agreement with Bank B in which he will make fixed-rate payments in exchange for receiving floating- rate payments based on LIBOR plus 100 basis points. Assume that payments are made quarterly in arrears based on a 360-day year. The fixed rate on the swap is 6.5%. The current interest rates on 90, 180, 270, and 360-day LIBOR are 5.2%, 5.5%, 5.8%, and 6.0%, respectively. If the notional principal is SI00 million, what will Party A's net cash flow at the end of the first quarter equal?

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Explanations

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A. B. C.

Explanation

To calculate Party A's net cash flow at the end of the first quarter in the interest rate swap agreement, we need to determine the fixed-rate payment and the floating-rate payment.

Given:

  • Fixed rate on the swap: 6.5%
  • Notional principal: $100 million

First, let's calculate the fixed-rate payment. The fixed-rate payment is based on the fixed rate and the notional principal.

Fixed-rate payment = Fixed rate * Notional principal

Fixed-rate payment = 6.5% * $100 million

Fixed-rate payment = $6.5 million

Next, let's calculate the floating-rate payment. The floating-rate payment is based on LIBOR plus 100 basis points. We need to find the applicable LIBOR rate for the quarter and add 100 basis points (1%).

The applicable LIBOR rate for the first quarter is the 90-day LIBOR, which is 5.2%.

Floating-rate payment = (LIBOR + 100 basis points) * Notional principal

Floating-rate payment = (5.2% + 1%) * $100 million

Floating-rate payment = 6.2% * $100 million

Floating-rate payment = $6.2 million

Since the payments are made quarterly in arrears, the net cash flow at the end of the first quarter is the difference between the fixed-rate payment and the floating-rate payment.

Net cash flow = Fixed-rate payment - Floating-rate payment

Net cash flow = $6.5 million - $6.2 million

Net cash flow = $300,000

Therefore, Party A's net cash flow at the end of the first quarter is +$300,000. None of the given answer choices match this result.

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