Calculate the interest rate paid by MdP six years after the beginning of the deal in Business Snapshot 24.2 if the Euribor rate proves to be 8% from year 2 onward.

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BUSINESS SNAPSHOT 24.2 The Santander Rail Deal In 2007, the Portuguese rail company Metro do Porto (MdP) was looking for a way to reduce its 4.76% per annum funding costs. After consulting a number of banks, it agreed to a 14-year swap with the Spanish bank Santander. In this swap, Santander paid the 4.76% funding cost and in return MdP paid 1.76% plus a spread. For the first two years, the spread was zero, saving MdP 3% on its funding. After that, the spread was calculated each quarter as max[0%, Previous Spread + 2 x max(2%-R, 0) + 2x max(R-6%, 0)-D] where R is the three-month Euribor rate and D, referred to as the DigiCoupon, is 0.5% if R lies between 2% and 6%, and zero otherwise. At the start of the deal, three-month Euribor was about 4%. If it had stayed between 2% and 6% for the whole 14 years, MdP would have saved 3% per annum on its funding for the whole period. As it happened, three-month Euribor had dropped below 2% by 2009 when the deal was only two years old, and it stayed below 2% for several years. As a result, the spread increased rapidly, reaching 40.6% in September 2013. The problem for MdP was that the spread in one quarter is dependent on the spread in the previous quarter. Suppose that three-month Euribor is 0.5% from year 2 onward. MdP's spread would increase by 3% per quarter or 12% per year. If subsequently three- month Euribor increases so that it is in the 2% to 6% range, the spread declines, but only at the rate of 0.5% per quarter or 2% per year. The deal was subject to a lawsuit. (Disputes over other similar deals entered into by Santander with other Portuguese state- owned entities were settled out of court.) MdP should of course have run scenario analyses to understand the potential costs of the transaction. Whether it did this and whether it understood the cumulative nature of the spread adjustments is not known. Possibly, it overweighted the attractiveness of saving 3% per year for the first two years. According to an article in Risk magazine in 2014, one London-based corporate hedging adviser has described this deal as a contender for the worst trade of all time!