Assignment On Analysis Of Cash Flow Of Microsoft

(Millions in dollars) Date LIBOR Rate Mar 5, 2007 Sep 5, 2007 Mar 5, 2008 Sep 5, 2008 Mar 5, 2009 Sep 5, 2009 Mar 5, 2010 4.2 % 4.8 % 5.3% 5.5% 5.6% 5.9% 6.4% +2.10 +2.40 +2.65 +2.75 +2.80 +2.95 -2.5 -2.5 -2.5 -2.5 -2.5 -2.5 -0.4 -0.1 +0.15 +0.25 +0.30 +0.45 FLOATING Cashflow FIXED Cashflow NET Cashflow

Analysis of the above table:

In the above table, Microsoft and Intel enter into interest rate swap for three year with notional principal of 100 million. Microsoft agrees to pay a fixed interest of 5% semi annually. On the other hand Intel agrees to pay Microsoft the 6-month LIBOR rate. Here Microsoft is a fixed rate payer whereas Intel is a floating rate payer. The first exchange of payments would take place on September 5, 2007, 6 months after the initiation of the agreement. There is no uncertainty about the first exchange of payments because it is determined by the LIBOR rate at the time the contract is entered into. The major reason behind using the LIBOR rate of six month ago is to maintain the liquidity at the payment date. Microsoft would pay Intel $2.5 million (i.e. ( 100*0.05) / 2 ) as a fixed payment but Intel would pay Microsoft interest on the $100 million principal at the 6-month LIBOR rate prevailing 6 months prior to the September 5, 2007- that is, on March 5, 2007. Suppose that the 6-months LIBOR rate on March 5, 2007 is 4.2%. Intel pays Microsoft 0.5 * 0.042 * 100= $2.1 Million.

5% INTEL LIBOR MICROSOFT

Interest rate swap between Microsoft and Intel The second exchange of payments would take place on March 5, 2008, a year after the initiation of the agreement. Microsoft would pay $2.5 million to Intel. Intel would pay interest on the $100 million principal to the Microsoft at the 6-month prior to March 5, 2008 that is, on September 5, 2007. Suppose that the 6-month LIBOR rate on September 5, 2007, is 4.8%. Intel pays 0.5 * 0.048 * $100= $2.4 million to Microsoft In total there are six exchanges of payment of swap. The fixed payments are always $2.5 million. The floating- rate payments are calculated using the 6-month LIBOR rate prevailing 6 months before the payment date. An interest rate is generally structured so that one side remits the difference between the two payments to the other side. In our example, Microsoft would pay Intel $0.4 million (= $ 2.5 million - $ 2.1 million) on September 5, 2007 and $ 0.1 million ( = $2.5 million - $ 2.4 million) on March 5, 2008. This table provides a complete example of the payments made under the swap for one particular set of 6 month LIBOR rates. The table shows the swap cash flows from the perspective of Microsoft. We should note that the $100 million principal is used only for the calculation of the interest payments. Conclusions drawn: Both the parties ( Intel and Microsoft )receives interest but the nature of interest varies. Principal is never used but is just used for calculation of interest. The swap can be regarded as the exchange of a fixed interest rate for a floating interest rate The difference check is positive when fixed rate is higher than the floating rate or vice versa.

Submitted by: Mandira Thapaliya Roll no.9 Manikkya