Hi, was just wondering if anyone can explain to me how LIBOR rates are used.
For example, consider a hypothetical situation where Microsoft and Intel enters a 3 year swap. Suppose Microsoft agrees to pay Intel an interest rate of 5% p.a compounded semiannually on a principal of $100 million and Intel pays Microsoft at the floating LIBOR rate. The 3 year swap is initiated on March 5, 2010.
So I know that on September 5, 2010 (after 6 months). Microsoft will pay $2.5 million. But then Intel would have to pay Microsoft using the March 6-month LIBOR rate. Assume the March 6 month Libor rate is 4.2%. Does that mean Intel will pay Microsoft 0.042*100mil = 4.2 mill? How come my book says Intel pays Microsoft 0.5*0.042*100mill = 2.1 mill? Where does the 0.5 come from?
Thanks
edit: nvm i found out that x-month LIBOR rates are actually quoted as an APR (the x month is for the actual length of each transaction in the swap conditions) and they're compounded at the compounding frequency of the interest rate swap conditions.