Two corporate borrowers enter into an interest swap agreement with a notional amount of $25M and annual net payments. Party A takes the fixed side of the swap at a rate of 3.25%, while Party B takes the floating rate side of the swap at a rate of LIBOR plus 125 bp. If at the end of the year, LIBOR is at 1.5%, who will owe money to the other party and how much?

Question

BlackTom AI · Accepted Answer

First, identify the cash flows on each leg of the swap based on the notional amount of 25 million.
- Party A pays fixed: 3.25% of 25,000,000 = 0.0325 × 25,000,000 = 812,500.
- Party B pays floating: LIBOR + 125 basis points. With LIBOR = 1.5%, this is 1.5% + 1.25% = 2.75% of 25,000,000 = 0.0275 × 25,000,000 = 687,500.
Now compare who pays whom: A’s fixed payment is 812,500; B’s floating payment is 687,500. Since A pays 812,500 and would receive 687,500 from B for the floating leg, the net payment is 812,500 − 687,500 = 125,000.
- If the net is positive for A (A pays more than receives), A owes money to B.
- If the net were negative, B would owe A.
Here, net = 125,000 in favor of B receiving from A.
Therefore, Party A owes Party B 125,000.

Option by option analysis:
- Option: "A owes B, $125,000" — This matches the computed net: A’s fixed payment exceeds B’s floating payment by 125,000, so A pays that amount to B.
- Option: "B owes A, $250,000" — This would require either a larger fixed payment or a larger floating payment difference; neither holds given the rates and notional.
- Option: "B owes A, $125,000" — This would imply the floating payment exceeds the fixed payment by 125,000, which is not the case here.
- Option: "A owes B, $250,000" — This would mean a net of 250,000, which would require a larger discrepancy between fixed and floating payments than exists with 3.25% fixed and 2.75% floating on the given notional.
Thus, only the first option correctly reflects the net settlement amount and direction.

FA25-BL-BUS-F307-1134

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