Alternative (but as similar as possible) scenario with Fair Value Hedge Jan. 1:
ID: 2818569 • Letter: A
Question
Alternative (but as similar as possible) scenario with Fair Value Hedge
Jan. 1: Northwest Borrows $50,000,000 from Bank at a 7% Annual Interest Rate
Jan. 1: Northwest enters swap agreement with a variable interest rate pay leg and a receive leg that is 7% with a notional amount of $50,000,000
Applicable Variable Rates:
March 31st: 6.5%
June 30th: 6.85%
Sep. 30th: 7.25%
Dec. 31st: 7.1%.
Fair Value of Swap on Each Date:
March 31st: 150,000
June 30th: (225,000)
Sep 30th: (175,000)
Dec. 31st: (210,000)
Fair Value of the Note on Each Date:
March 31st: 50,150,000 = 50,000,000 + 150,000
June 30th: 49,775,000
Sep. 30th: 49,825,000
Dec. 31st: 49,790,000
Calculate and record the entries for the given quarters using a Fair Value Hedge. Please show work.
Explanation / Answer
A swap is basically an exchange of cash flows arising from the interest rate changes. So this question has two components. 1) recording of interest expense 2) recording debt and the swap at fair value
Since, the company has agreed to pay the variable interest rate, its cash flow will depend on the variable interest expense and we need to pass journal entries to show that net cash flow from variable stream.
Description of journal enteries is given below each entry and the table is self-explanatory.
Quarterly Payment Difference between Fixed rates Variable interest rate on swap Sum of rates Debt's principal amount Quarterly interest Fixed Interest Gain / loss Mar-31 0% 6.50% 6.50% 50000000 812500 875000 62500 Jun-30 0% 6.85% 6.85% 50000000 856250 875000 18750 Sep-30 0% 7.25% 7.25% 50000000 906250 875000 -31250 Dec-31 0% 7.10% 7.10% 50000000 887500 875000 -12500 Date Variable Rate Fair Value of Swap Debt Fair Value Mar-31 6.50% 150000 50150000 Jun-30 6.85% -225000 49775000 Sep-30 7.25% -175000 49825000 Dec-31 7.10% -210000 49790000Related Questions
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