Amazon corporation and Microsoft corporation agree to enter an interest swap agreement with a nominal value of $1,000,000. The two companies enter into two-year interest rate swap contract with the specified nominal value of $1,000,000. Amazon corporation offers Microsoft corporation a fixed rate of 5% in exchange for receiving a floating rate of the LIBOR rate plus 1%. The current LIBOR rate at the beginning of the interest rate swap agreement is 4%. a) If LIBOR rate increases to 5.25% by the end of the first year what are the payment due between both companies? Assume interest payment will be made annually and the floating rate for Microsoft corporation will be calculated using the prevailing LIBOR rate at the time that interest payments are due. b) Critically evaluate interest rate swap agreements focusing on their significance and advantages in financial management.
Amazon corporation and Microsoft corporation agree to enter an interest swap agreement with a nominal value of $1,000,000. The two companies enter into two-year interest rate swap contract with the specified nominal value of $1,000,000. Amazon corporation offers Microsoft corporation a fixed rate of 5% in exchange for receiving a floating rate of the LIBOR rate plus 1%. The current LIBOR rate at the beginning of the interest rate swap agreement is 4%.
a) If LIBOR rate increases to 5.25% by the end of the first year what are the payment due between both companies? Assume interest payment will be made annually and the floating rate for Microsoft corporation will be calculated using the prevailing LIBOR rate at the time that interest payments are due.
b) Critically evaluate interest rate swap agreements focusing on their significance and advantages in
a)
| Amazon | Microsoft | |
| Interet rate type | Fixed rate | Floating rate |
| Nominal value of contract | $1,000,000 | $1,000,000 |
| Interest rate on start of agreement when LIBOR is 4% | 5% | LIBOR + 1% = 5% |
| Interest rate at the end of Year 1 when LIBOR is 5.25% | 5% | 6.25% |
| Interest payment due at end of Year 1 |
=5% of $1,000,000 =$50,000 |
=6.25% of $1,000,000 =$62,500 |
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