COMPONENT II: QUANTITATIVE [ILO: B1] (18%)

Suppose in an interest rate swap the notional principal is $10,000,000 with a swap period of 2 years. Two companies agree to exchange a fixed for a floating income stream. Barmko agrees to pay 10% to Darmko. Darmko agrees to pay Barmko LIBOR+ 4%

PART A1: Suppose at the end of the first year LIBOR is 8%, which party and how much will that party net?

(SHOW CALCULATIONS HERE. USE NO TEXT)

Barmko pays Darmko: _______________________________ (1 )

Darmko pays Barmko: ________________________________ (1 )

Barmko nets from Darmko: ___________________________ (1)

PART A2: Suppose that the end of the second year LIBOR is 11%, which party and how much will that party net?

(SHOW CALCULATIONS HERE. USE NO TEXT)

Barmko pays Darmko: _______________________________ (1 )

Darmko pays Barmko: ________________________________ (1 )

Barmko nets from Darmko: ___________________________ (1)

Over the two years Barmko nets from Darmko: ________________________________ (1)

PART B: As a hedge, Darmko buys a two-year cap on a 6 month LIBOR of $10,000,000 with current LIBOR at 4%, suppose that in the

• first six months LIBOR rises to 7%
• second six months LIBOR rises to 8%
• third six months LIBOR rises to 9%
• fourth six months LIBOR rises to 11%

What will be the overall cash position of Darmko, as a holder of both the interest rate swap above and the cap at 4%, at the end of two years? (Assume the cost of the cap is $300,000)

(SHOW CALCULATIONS HERE. USE NO TEXT)

1^st six months: ______________________________ (1 )

2^nd six months: ______________________________ (1 )

3^rd six months: _______________________________ (1 )

4^th six months: _______________________________ (1 )

Sum (over two year period) = ____________________________ (1)

After hedge of the i-rate swap

with the cap, the net position of Darmko = ________________________________ (2)