In this workout, we take a look at a fixed-for-floating swap arrangement where there's a swap dealer involved. So the transaction is as follows: A, the payer, enters into a fixed-for-floating swap arrangement with B, the receiver, via a swap dealer. At the date the swap is created, the dollar one year LIBOR is 4.28%. The terms of agreement are as follows: the swap rate on the day was 5.48 at 5.52. What does this mean, you ask? Well, 5.48 is the bid the dealer is quoting, so that is what fixed rate he's willing to pay. His offer is 5.52. That is the fixed rate he is willing to accept, to receive. Tenor of the swap was two years. The notional is million dollars. The frequency is annual, and the floating rate is US dollar one year LIBOR.
What will be the net variable rate cash flows for the intermediary swap dealer in year two if US dollar one year LIBOR has increased to 4.68 at the end of year one? Well, the variable rate cash flow received, of course, will still be the variable rate. So 4.68% times the notional.
And of course, the dealer is also paying the variable rate, so it'll pay out exactly the same amount. So of course, its net cash flow here on the variable leg is zero, so it's totally neutral there. In fact, it wouldn't have mattered whether the LIBOR was up or down, of course.
In workout B, we're taking a look at exactly the same trade; same conditions as in workout A. However, the question is here: what will be the net fixed rate cash flows for the intermediary swap dealer in year two if US dollar one year LIBOR has increased to 4.68% at the end of year one? So it's the fixed rate cash flows we're looking at here. Well, the fixed rate cash flows the dealer has received, that was his offer when the trade was done. That is 5.52% times the notional.
The fixed rate cash flows he's paying out, of course, would be his bid on the day the trade was done. So, we'll pay out 5.48% times the notional.
And of course, the net cash flow here will be the difference there: $400. So the $400 here, of course, is the profit for the dealer.
Interest Rate Swaps Dealer Workout Empty
