Question 1. Plain Vanilla Interest Rate Swap Incredible Inc., a manufacturer of children’s toys, enters into a two-year plain vanilla interest rate swap, in which the corporation will re
D&R A3
1-2
Question 1. Plain Vanilla Interest Rate Swap
Incredible Inc., a manufacturer of children’s toys, enters into a two-year plain vanilla interest rate swap, in which the corporation will receive a fixed rate and pay a floating rate of LIBOR. The notional amount on this swap is $75 million. Swap payments will be netted every 180 days, and the LIBOR requires the assumption of a 360-day year. The term structure of LIBOR on the swap initiation date is as follows:
|
Days |
Rate (%) |
|
180 |
3.50 |
|
360 |
3.55 |
|
540 |
3.60 |
|
720 |
3.70 |
- Calculate the swap value on the initiation date.
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9) Exercise A-5 (Static) Derivatives; interest rate swap; fixed rate debt; extended method [LOA–6]
On January 1, 2021, LLB Industries borrowed $200,000 from Trust Bank by issuing a two-year, 10% note, with interest payable quarterly. LLB entered into a two-year interest rate swap agreement on January 1, 2021, and designated the swap as a fair value hedge. Its intent was to hedge the risk that general interest rates will decline, causing the fair value of its debt to increase. The agreement called for the company to receive payment based on a 10% fixed interest rate on a notional amount of $200,000 and to pay interest based on a floating interest rate. The contract called for cash settlement of the net interest amount quarterly.
Floating (LIBOR) settlement rates were 10% at January 1, 8% at March 31, and 6% at June 30, 2021. The fair values of the swap are quotes obtained from a derivatives dealer. Those quotes and the fair values of the note are as follows:
| January 1 | March 31 | June 30 | |||||||
| Fair value of interest rate swap | 0 | $ | 6,472 | $ | 11,394 | ||||
| Fair value of note payable | $ | 200,000 | $ | 206,472 | $ | 211,394 | |||
Required:
Prepare the journal entries through June 30, 2021, to record the issuance of the note, interest, and necessary adjustments for changes in fair value. (Round your intermediate and final answers to the nearest whole dollar. If no entry is required for a transaction/event, select "No
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