An investor owns $60 million in bonds issued by Crab Key Industries. The bonds are rated single A and have a fixed coupon rate of 5%. The investor listens to a podcast and learns that the economic analytics predicts a 90% chance of a substantial increase in rates over the next three years. The investor becomes super worried and initially believes the solution is to sell the current bonds and replace them with floating rate bonds. After listening to a different podcast, the investor decides to use a swap contract to hedge this interest rate risk. The fixed swap rate is 5.1% and the floating rate is SOFR plus 225 basis points. Potential SOFR rates for years 1, 2, and 3 are 1.6%, 3.9%, and 5.8%.

1. Draw the diagram that shows the arrows for both the investor as a bondholder and the direction of the swap payments.

2. Compute the net payments if the investors decides to hedge one-half of the position.