XYZ company has entered into a "plain-vanilla" interest rate swap on $1,000,000 notional principal. XYZ company pays a fixed rate of 8 percent on payments that occur at 90-day intervals. Six payments remain with the next one due in exactly 90 days. On the other side of the swap, XYZ company receives payments based on the LIBOR rate. Describe the transaction between XYZ company and the dealer at the end of the sixth period if the appropriate LIBOR rate is 5 percent.
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A. B. C. D.D
XYZ company owes the dealer ($1,000,000)(.08)(90/360) = $20,000. The dealer owes XYZ company ($1,000,000)(.05)(90/360) = $12,500. Net: XYZ company pays the dealer $7,500.
In this scenario, XYZ company has entered into a "plain-vanilla" interest rate swap on a notional principal amount of $1,000,000. Let's break down the terms and conditions of the swap:
XYZ company pays a fixed rate of 8 percent on payments that occur at 90-day intervals: This means that XYZ company agrees to pay a fixed interest rate of 8 percent on the notional principal amount ($1,000,000) in every 90-day period.
Six payments remain with the next one due in exactly 90 days: This implies that there are six remaining payment periods, including the one that will occur in 90 days. The payments are made at the end of each 90-day period.
XYZ company receives payments based on the LIBOR rate: In this swap, XYZ company receives payments from the dealer based on the LIBOR rate. LIBOR stands for London Interbank Offered Rate, which is a benchmark interest rate at which banks lend to one another in the international interbank market.
Now, let's calculate the payments for XYZ company and the dealer based on the given information:
The fixed rate that XYZ company pays on the notional principal amount is 8 percent. As the payment intervals are 90 days, each payment period represents one-fourth of a year.
Therefore, for each payment, XYZ company will pay (1/4) * 8% * $1,000,000 = $20,000.
Since there are six remaining payment periods, the total amount that XYZ company will pay to the dealer over the remaining periods is 6 * $20,000 = $120,000.
On the other side of the swap, XYZ company receives payments based on the LIBOR rate. The appropriate LIBOR rate is given as 5 percent.
To calculate the payment that XYZ company receives based on the LIBOR rate, we need to determine the interest amount based on the LIBOR rate for each payment period. The interest amount can be calculated by multiplying the LIBOR rate by the notional principal amount.
For each payment, XYZ company will receive (1/4) * 5% * $1,000,000 = $12,500.
As there are six remaining payment periods, the total amount that XYZ company will receive from the dealer over the remaining periods is 6 * $12,500 = $75,000.
At the end of the sixth period, we need to determine the net transaction between XYZ company and the dealer. To calculate this, we subtract the amount XYZ company receives from the amount it pays:
Net transaction = Amount received - Amount paid = $75,000 - $120,000 = -$45,000
The negative sign indicates that XYZ company will pay the dealer $45,000 at the end of the sixth period.
Therefore, the correct answer is: D. XYZ company pays the dealer $7,500.