Question
On January 1 2020, Alpha inc. has $1,000,000 in assets that earns a floating rate of interest of LIBOR + 0.5% with maturity in 3
On January 1 2020, Alpha inc. has $1,000,000 in assets that earns a floating rate of interest of LIBOR + 0.5% with maturity in 3 years on January 1 2023. Alpha inc. also has an existing debt of $1,000,000 on which it pays a fixed rate of interest of 4% with maturity in three years on January 1 2023. Alpha inc. sees a potential opportunity to hedge its interest rate risk by entering into an interest rate swap to transform the $1,000,000 existing debt of Alpha inc.
The swap has a maturity of three years, maturing on January 1 2023. Payments are exchanged once on January 1 of each year. The fixed rate leg of the swap has an interest rate of 4% (annual rate with annual compounding) and the floating rate leg of the swap has an interest rate equivalent to the 1-year LIBOR + 0.75%.
On January 1 2021, the zero coupon 1-year LIBOR rate was 4.5% (annual rate with continuous compounding). On July 1 2021, the zero-coupon 6-month, 1-year, 1.5-year and 2-year LIBOR rates are 4.7%, 4.9%, 5.3%, and 5.7% respectively (annual rate with continuous compounding). The annual forward rate for a loan starting in 6 months and ending in 1.5 years is 4.8% (annual rate with continuous compounding).
On July 1 2021, Alpha Inc. wants to know what the value of the swap is. Assume OIS and LIBOR rates are the same.
What is the value of the swap?
A. -$28,611
B. $28,611
C. -$12,272
D. $12,272
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