[10 Marks]

A Ltd and B Corporation negotiate a $15 million, 7-year interest-rate swap in which A will pay a 4.25% fixed rate to B, and B will pay Libor to A (there is no swap dealer involved). The firms will net payments half-yearly. A generally pays Libor plus 20 basis points for borrowing, and B borrows at 4.10%.

Determine the all-in-cost for A and B. It may be useful to create a diagram showing the payment responsibilities of each firm.

Suppose that after three years, the market offers a swap rate of 3.35% against Libor. A swap dealer offers to take the swap off As hands. How much will A have to pay the dealer? Explain why interest only is paid or why interest and principal are paid.