Incredible Inc., a manufacturer of children's toys, enters into a two-year plain vanilla interest rate swap, in which the corporation will receive a fixed rate and pay a floating rate of LIBOR. The notional amount on this swap is $75 million. Swap payments will be netted every 180 days, and the LIBOR requires the assumption of a 360-day year. The term structure of LIBOR on the swap initiation date is as follows:

Days

Rate (%)

180

3.50

360

3.55

540

3.60

720

3.70

a.What is the fixed rate determined on the swap initiation date? (6 marks)

b.Calculate the swap value on the initiation date. (1 mark)

c.What is the first net payment on the swap? Who makes this payment, Incredible Inc. or the swap dealer? (1 mark)

d.Assume that it is now 120 days into the life of the swap. The new term structure of LIBOR is as follows:

Days

Rate (%)

60

3.60

240

3.70

420

3.80

600

3.90

Calculate the value of the swap on Day 120. (6 marks)

e.Assume that it is now 360 days into the life of the swap. The new term structure of LIBOR is as follows:

Days

Rate (%)

180

3.85

360

3.90

540

3.95

720

4.00

Calculate the net payment on the swap on Day 540, and the value of the swap on Day 360. (6 marks)