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CA Final · Advanced Financial Management · Derivatives Analysis and Valuation

Meridian Textiles Ltd has entered a plain vanilla interest rate swap on a notional principal of ₹50 crore. It pays a fixed rate of 8% p.a. and receives a floating rate linked to MIBOR, with annual settlement on a net basis. For the settlement period, the floating rate is fixed at 7.2%. What is the net settlement for Meridian?

Meridian pays a net ₹40 lakh. It pays fixed 8% and receives floating 7.2% on a ₹50 crore notional, so the net 0.8% difference is payable by the fixed-rate payer. Only the interest differential is settled, and no principal changes hands.

  1. APays ₹40 lakhCorrect
  2. BReceives ₹40 lakh
  3. CPays ₹4 crore
  4. DReceives ₹3.6 crore

Explanation

Net settlement is on the notional principal only, and principal is never exchanged. The fixed payer pays 8% and receives 7.2%, so the net is (8% − 7.2%) × ₹50 crore = 0.8% × ₹50 crore = ₹40 lakh payable. Receiving ₹40 lakh gets the direction wrong, because floating is below fixed.

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