Risk Averse Bank (RAB) has made a loan of USD 100 million at 8% per annurn.RAB wants to enter into a total return swap under which it will pay the interest on the loan plus the change in the mark-to-market value of the loan and in exchange,RAB will get LIBOR+30bps. Settlement payments are made annually. What is the cash flow for RAB on the first settlement data ifthe rnark-to-market value of the loan falls by 2% and LIBOR is 6%?
A. Net inflow of USD 0.3 million
B. Net outflow of USD 0.3 million
C. Net inf10w of USD 1.7 million
D. Net outflow of USD 1.7 million
Answer:A
At the end of the first year, RAB will eam 8 million USD interest on the loan. The loan value declined by 2 million USD, thus the retum eamed by RAB is 6 million USD; this is the payment made by RAB. RAB will get LIBOR+30bps = 6% + 0.3% = 6.3%, that is 6.3 million USD. So there is a net inflow of 0.3 million.