On January 2, 2011, MacCloud Corp. issued a $100,000, four-year note at prime plus 1%
variable interest, with interest payable semi-annually. MacCloud now wants to change the note to a fixed-rate note. As a result, on January 2, 2011, MacCloud Corp. enters into an interest rate swap where it agrees to pay 6% fixed and receive prime plus 1% for the first six months on $100,000. At each six-month period, the variable rate will be reset. The prime interest rate is 5.7% on January 2, 2011, and is reset to 6.7% on June 30, 2011.
Instructions
(a) Calculate the net interest expense to be reported for this note and related swap transaction as of June 30 and December 31, 2011.
(b) Prepare the journal entries relating to the swap for the year ended December 31, 2011.
(c) Explain why this is a cash flow hedge.