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A company enters into a five-year interest rate swap along with a swap bank where it agrees to pay the swap bank a fixed-rate of 9.75 percent yearly on a notional amount of DM15,000,000 and receive LIBOR - ½%. As of the second reset date, find out the price of the swap from the corporation's viewpoint; assume that the fixed-rate at which it can borrow has risen to 10.25 percent.
Solution: On the reset date, the present value of the future floating-rate payments the corporation will receive from the swap bank based upon the notional value will be DM15,000,000. The present value of a hypothetical bond issue of DM 15,000,000 along with three remaining 9.75% coupon payments at the new fixed-rate of 10.25 percent is DM14,814,304. This sum denotes the present value of the remaining payments the swap bank will receive from the corporation. So, the swap bank should be willing to buy and the corporation should be willing to sell the swap for DM15, 000, 000 - DM14, 814, 304 = DM185,696.
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