1. Interest Rate Swap chap 8 1) Interest rate swap You have borrowed floating rate debt. At present you are paying LIBOR + 2% per annum for the next four years, with payments due annually. The next payment is due one year from today. You believe interest rates are going to rise: LIBOR is currently 4.00% per annum and is expected to rise at the rate of 1% per year Year 1 Year 2 Year 3 Year 4 LIBOR 5.00% 6.00% 7.00% 8.00% a) b) How to hedge the interest rate risk using a swap agreement? If you can swap floating rate for fixed payments of 6.00% per annum, what are you net interest rates in the next four years? Loan interest rates Year 1 Year 2 Year 3 Year 4 (1) LIBOR (2) Spread 3) Total loan interest rate Swap interest rates 4) Pay fixed 5) Receive LIBOR (6) Net interest due after swap c) Ifyou borrow $1,000,000, calculate how much interest payment you save or lose each year by making this swap 1. Interest Rate Swap chap 8 1) Interest rate swap You have borrowed floating rate debt. At present you are paying LIBOR + 2% per annum for the next four years, with payments due annually. The next payment is due one year from today. You believe interest rates are going to rise: LIBOR is currently 4.00% per annum and is expected to rise at the rate of 1% per year Year 1 Year 2 Year 3 Year 4 LIBOR 5.00% 6.00% 7.00% 8.00% a) b) How to hedge the interest rate risk using a swap agreement? If you can swap floating rate for fixed payments of 6.00% per annum, what are you net interest rates in the next four years? Loan interest rates Year 1 Year 2 Year 3 Year 4 (1) LIBOR (2) Spread 3) Total loan interest rate Swap interest rates 4) Pay fixed 5) Receive LIBOR (6) Net interest due after swap c) Ifyou borrow $1,000,000, calculate how much interest payment you save or lose each year by making this swap