Question

Schifano Motors of Italy recently took out a 4-year €5 million loan on a floating rate basis. It is now worried, however, about rising interest costs. Although it had initially believed interest rates in the Eurozone would be trending downward when taking out the loan, recent economic indicators show growing inflationary pressures. Analysts are predicting that the European Central Bank will slow monetary growth driving interest rates up. Schifano is now considering whether to seek some protection against a rise in euro-LIBOR, and is considering interest swap strategies. LIBOR is currently 6.50% and would rise at the rate of 50 basis points per annum, starting tomorrow. Schifano has just made the first interest payment today, so the next payment is due 1 year from today. Schifano finds that she can swap her current floating rate payments for fixed payments of 7.00% per annum.

What interest swap strategy should Schifano use?

Calculate how much Schifano save by making the correct swap?

Answer 1

in question interest on Schifano's loan is floating but not clear that interest levy on laon equal to LIBOR .therefore it is assumed that interest on Schifano's laon levy by LIBOR rate. here laon period is 4 year and one year has been lapse.. she took a swap from 2nd year

If LIBOR rate increase 0.50 point basis per year . here Floating rates are -

2nd year 6.50 + 0.50 = 7.00 %

3rd year 7.00 +0.50 = 7.50 %

4th year 7.50 + 0.50 = 8.00 %

Calculation of savings of interest - ( swap fixed rate = 7 %)

(Amounts in EURO)

Year	floating inrerest	fixed interest	Saving
2	5000000* 7% = 350000	5000000* 7% = 350000	0
3	5000000*7.50% = 375000	350000	25000
4	5000000*8.0% = 400000	350000	50000
		Total Savings	75000

By taking swap she saved a amount of Euro 75000 of interest on this loan.