1. Your firm (AAA credit rating) is considering its options with regard to changing the nature of its
outstanding liabilities. You currently have a dollar-denominated $10,000,000 bond outstanding. It
is a \"plain vanilla\" bond, with a fixed semi-annual coupon rate of 5% (5% annual percentage rate
(APR); semiannual payments), two years remaining until maturity. The yield curve is flat and the
yield to maturity of this bond is 5 percent.
The cash flows look like this:
today
$250,000
$250,000
$250,000
$10,250,000
\frac{1}{2} year
1 year
1\frac{1}{2} years
2 years
a) Fabricate a feasible (interest only) swap that will allow your firm to redenominate the interest
portion of this fixed rate dollar-denominated liability into a floating rate dollar denominated
liability. Swaps are quoted against \"flat\" U.S. dollar LIBOR
USD
Bid
Ask
5.5
5.75
b) Today LIBOR is at 4.9% and in six months LIBOR is 5.2%. What is the amount of the first
payment of this swap? Please be clear as to who pays how much to whom.