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Question 14.20: Orono Bank and the Portland Manufacturing Corp. enter into t...

Orono Bank and the Portland Manufacturing Corp. enter into the following seven-year swap with a notional amount of $75 million and the following terms: Every year for the next seven years, Orono Bank agrees to pay Portland Manufacturing 7% per year and receive LIBOR from Portland Manufacturing.
a. What type of swap is this?
b. In the first year payments are to be exchanged, suppose that LIBOR is 4%. What is the amount of the payment that the two parties must make to each other?

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a. Interest rate swap
b. Orono pays 7% × $75 million = $5,250,000; Portland pays 4% × $75 million = $3,000,000. The net payment (Orono to Portland) is $2,250,000, or 3% of $75 million.

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