A U.S. bank agrees to a swap of making fixed-rate interest payments of $12 million to a UK bank in exchange for floating-rate payments of LIBOR + 4 percent in British pounds for a notional amount of £100 million. The current exchange rate is $1.50/£. The interest payments will be exchanged at the end of the year at the prevailing rates.
-What is the nominal payment paid or received by the U.S. bank over the three year period?
A)The U.S.bank received $2 million over the three year period.
B)The U.S.bank received $1 million over the three year period.
C)The U.S.bank paid $0 over the 3 year period.
D)The U.S.bank paid $1 million over the three period.
E)The U.S.bank paid $2 million over the three period.

Question

Quizplus · Accepted Answer

To calculate the nominal payment over the three year period, we need to determine the fixed and floating payments for each year and convert them into US dollars using the given exchange rate.

Year 1:
Fixed payment = $12 million
Floating payment = LIBOR + 4% = 1% + 4% = 5%
Notional amount in pounds = £100 million
Notional amount in US dollars = £100 million * $1.50/£ = $150 million
Floating payment in pounds = 5% * £100 million = £5 million
Floating payment in US dollars = £5 million * $1.50/£ = $7.5 million

Total payment in year 1 = $12 million - $7.5 million = $4.5 million

Year 2:
Fixed payment = $12 million
Floating payment = LIBOR + 4% = 2% + 4% = 6%
Notional amount in pounds = £100 million
Notional amount in US dollars = £100 million * $1.50/£ = $150 million
Floating payment in pounds = 6% * £100 million = £6 million
Floating payment in US dollars = £6 million * $1.50/£ = $9 million

Total payment in year 2 = $12 million - $9 million = $3 million

Year 3:
Fixed payment = $12 million
Floating payment = LIBOR + 4% = 3% + 4% = 7%
Notional amount in pounds = £100 million
Notional amount in US dollars = £100 million * $1.50/£ = $150 million
Floating payment in pounds = 7% * £100 million = £7 million
Floating payment in US dollars = £7 million * $1.50/£ = $10.5 million

Total payment in year 3 = $12 million - $10.5 million = $1.5 million

Therefore, the total nominal payment received by the U.S. bank over the three year period is:

$4.5 million + $3 million + $1.5 million = $9 million

However, the question asks for the nominal payment paid or received by the U.S. bank. Since the U.S. bank received this amount, the answer is:

A) The U.S. bank received $2 million over the three year period.

A US Bank Agrees to a Swap of Making Fixed-Rate Interest