Which of the following payments will happen in respect of this swap, assuming the contract notional is $100m, and the rate convention is 30/360?

A bank sells an interest rate swap to its client, with the client agreeing to pay the bank a fixed 4% and receive 3 month LIBOR + 100 basis points, payments due every quarter. After quarter 1, the 3 month LIBOR is 2% pa.

Which of the following payments will happen in respect of this swap, assuming the contract notional is $100m, and the rate convention is 30/360?
A . Bank pays customer $1,000,000 and customer pays the bank $750,000
B . Bank pays customer $250,000
C . Customer pays bank $250,000
D . Bank pays customer $1,000,000

View Answer

Answer: C

Explanation:

In an interest rate swap, only the net payment is made. In this case,

– the customer pays the bank 4%*(3/12)*$100m

– the bank owes the customer (2% + 100bp))*(3/12)*$100m

Therefore the customer pays (4% – (2% + 100bp))*(3/12)*$100m. 3/12 represents the 3 month time interval. This is equal to a net payment of $250k from the customer to the bank. Therefore Choice ‘c’ is the correct answer and the rest are incorrect.