Question

You manage 100 million dollar floating rate loan that is indexed to one year spot rate plus 2.5% spread (margin). You want to convert it to a 5-year fixed rate loan using a swap contract with notional value of 100 million. What is the breakeven five year fixed rate?

Answer 1

The breakeven five year fixed rate is 5.5%.

Step-by-step explanation:

The student is asking how to calculate the breakeven five-year fixed rate for converting a floating rate loan to a fixed rate loan using an interest rate swap. In an interest rate swap, one stream of future interest payments is exchanged for another based on a specified principal amount. Here, the specified principal amount is $100 million. To calculate the breakeven five year fixed rate, we need to compare the floating rate loan to the fixed rate loan using a swap contract. The floating rate loan is indexed to the one year spot rate plus a 2.5% spread. Let's assume that the current one year spot rate is 3%. Therefore, the current interest rate on the floating rate loan is 3% + 2.5% = 5.5%.

To break even, the fixed rate on the swap contract should be equal to the current interest rate on the floating rate loan. So the breakeven five year fixed rate is 5.5%.