A financial institution has entered into an interest rate sw
Question and Solution
A financial institution has entered into an interest rate swap with company X. Under the terms of the swap, it receives
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A financial institution has entered into an interest rate swap with company X. Under the terms of the swap, it receives 10% per annum and pays 6-month LIBOR on a principal of $10 million for 5 years. Payments are made every 6 months. Suppose that company X defaults on the sixth payment date (at the end of year 3) when the LIBOR/swap interest rate (with semiannual compounding) is 8% per annum for all maturities. What is the loss to the financial institution? Assume that 6-month LIBOR was 9% per annum halfway through year 3.
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