The variable rate to be used at the end of year 3 is set at the end of 2½ years (the arrears method). Therefore, the appropriate variable rate is 9%, the fixed rate is 6.5%, and the interest payments are netted. The fixed-rate payer, counterparty B, pays according to:
(Swap Fixed Rate – LIBOR
t-1)(# of days/360)(Notional Principal).
In this case, we have (0.065 - 0.09)(180/360)($100 million) = $-1.25 million.
