PRM I question 160

[Anonymous]

Hello,

I don’t understand the answer to the question 160 of PRM I:
Question 160 : A bank sells an interest rate swap to its customer agreeing to pay fixed 4% and receive 3 month LIBOR + 100 basis points, payments due every quarter. After quarter 1, the 3 month LIBOR is 2% pa. Which of the following payments will happen in respect of this swap, assuming the contract notional is $100m, and the rate convention is 30/360.

(a) Bank pays customer $250,000

(b) Bank pays customer $1,000,000

(c) Bank pays customer $1,000,000 and customer pays the bank $750,000

(d) Customer pays bank $250,000

Your Answer is Incorrect

The correct answer is choice ‘a’

In an interest rate swap, only the net payment is made. In this case, the bank owes the customer (4% – (2% + 100bp))*(3/12)*$100m. 3/12 represents the 3 month time interval. This is equal to a net payment of $250k from the bank to the customer. Therefore Choice ‘a’ is the correct answer and the rest are incorrect.

I thought it was the opposite (answer d) ?

Thanks in advance

NP

[nadege]

PRM I question 160

[Anonymous]

Danoo,

You are absolutely right. The customer pays 4% while the bank only pays 2%+100bps. Therefore there is a net payment from the customer to the bank, and not the other way round.

Now corrected. Many thanks for pointing the error out. Appreciated,
Mukul

[Author]

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