Finance Junkie
Posts: 205
Joined: Mon Feb 04, 2013 3:35 pm


Postby » Tue Oct 08, 2013 2:21 am

Choose one
a. $1.927 million
b. $2.245 million
c. $2.624 million
d. $3.011 million
Bank One enters into a 5-year swap contract with Mervin Co. to pay LIBOR in return for a fixed 8% rate on a
nominal principal of $100 million. Two years from now, the market rate on 3-year swaps at LIBOR is 7%; at this
time Mervin Co. declares bankruptcy and defaults on its swap obligation. Assume that the net payment is made
only at the end of each year for the swap contract period. What is the market value of the loss incurred by Bank
One as result of the default?
Choose one answer.
The correct answer is $2.624 million.
At the new swap rate, the replacement cost on the swap is $1 million a year discounted at 7% for each of the 3
years, which is $2.624 million.

How did we arrive one million a year

Finance Junkie
Posts: 258
Joined: Thu Sep 20, 2012 3:42 pm


Postby pradeeppdy » Tue Oct 08, 2013 9:13 am

It is the difference of 1% (Fixed 8% - LIBOR 7% ) * 100 million.

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