The bank has granted a special loan that has 3 years to maturity and has repayments of $357.875 million at the end of year 1, no payment at the end of year 2 and $357.875 million payment at the end of year 3. The loan is trading at par of $650 million and the yield to maturity is 5 percent per annum.

The yield curve is flat and the interest rate is 5%. The financial institution decides to use a 3year swap. The swap is composed of a three-year bond with a fixed coupon rate of 5 percent paid annually and a floating-rate bond with duration of approximately zero.

Using this swap, determine the notional principal of the swap and advise the financial institution on whether it should be a fixed or floating payer. Present an explanation including pertinent assumptions of how the swap you have recommended works.