Problem
A financial institution has entered into an interest rate swap with company X. Under the terms of the swap, it pays 6- month Libor and receives 5% per annum on a principal of $10 million for five years. Suppose that company X defaults on its last payment of year 4, when the interest rate (with semiannual compounding) is 4%. What is the loss to the financial institution? Assume that the six-month Libor was 4.5% halfway through year 4.