Reference no: EM1367172

Question 1

On April 10, ABC inc. Enters in a swap contract for 10 years with a chartered bank to turn a fixed rate on liability of $150 million to floating rate. ABC wants to receive interest payments at a fixed rate in exchange for interest payments at a floating rate. The floating reference to the Canadian market is the bankers' acceptance rate 6 months. Given the average rate that you will find in the worksheet, calculate:

a) Explain briefly why such swap transforms a fixed rate liabilities of ABC inc. in floating rate liabilities.
b) The value of cash flows that ABC pays to the financial institution.
c) The value of the cash flows that ABC receives from financial institution.
d) The net cash flows received (paid) by ABC.

Data
Dates	6 month rates on bankers' acceptances (semi-annual compounding)	fixed rates on bankers' acceptances (semi-annual compounding)
10-avr.	3.00%	5.00%
10-oct.	3.30%	5.00%
10-avr.	3.70%	5.00%
10-oct.	4.50%	5.00%
10-avr.	6.10%	5.00%
10-oct.	7.50%	5.00%
10-avr.	6.25%	5.00%
10-oct.	5.00%	5.00%
10-avr.	3.40%	5.00%
10-oct.	3.70%	5.00%
10-avr.	4.10%	5.00%
10-oct.	5.10%	5.00%
10-avr.	5.00%	5.00%
10-oct.	4.90%	5.00%
10-avr.	5.30%	5.00%
10-oct.	6.20%	5.00%
10-avr.	5.90%	5.00%
10-oct.	4.50%	5.00%
10-avr.	4.00%	5.00%
10-oct.	3.80%	5.00%
10-avr.	3.10%	5.00%

Question 2

The comparative advantage argument is often used to explain the benefits of swaps. In the Excel file, you will find the cost of fixed rate and floating rate for two companies that do not have the same credit quality. AAA company wants to borrow at floating rate, while the BBB company wants to borrow at fixed rates.

a) Calculate the total gain (in terms of interest rates) that the two companies can achieve by entering into a swap between them.

b) Assuming that the gain is divided equally between the two companies, provide new financing costs for AAA (the example in your lecture notes on swaps should help)

c) Assuming that the gain is divided equally between the two companies, provide new funding costs for BBB (for help, use the example from your lecture notes on swaps).

d) Suppose the fixed rate for the BBB has been 7.4% instead of 8% (all other rates are unchanged). Would it have been possible to gain by entering into a swap between AAA and BBB? Why?

e) Explain briefly why the comparative advantage argument is misleading.

Data
	Fixed rate	Floating rate: rate on top on bankers' acceptances  with maturity 6 months
AAA	7.00%	0.10%
BBB	8.00%	0.50%

Question 3

To understand the dynamics of the swap, you will have to assess the value of a swap at various times of its life, using the approach of a bond portfolio. The date is January 1, the swap horizon is 1 year, the notional amount is $100 and the fixed rate associated with swap is indicated in the worksheet.

a) Convert rates from semi-annual to continuously compounded.

b) Calculate the value of the floating rate bond on January 1, April 1, July 2, 28 September and 31 December.

c) Calculate the value of fixed-rate bond on January 1.

d) Calculate the value of the swap for fixed payment for January 1st.

e) Calculate the value of fixed-rate bond on April 1.

f) Calculate the value of the swap for fixed payment for April 1st.

g) Calculate the value of the fixed rate bond at 31 December.

h) Calculate the value of the swap for fixed payment for December 31.

Data
Terms of the swap contract
Fixed rate	6.99452%
Floating rate	BA 6 months
Nominal amount	100
Maturity	1 year