Each of two companies decides to issue $10 million in 5-year debt on the same da

Question

Each of two companies decides to issue $10 million in 5-year debt on the same date. Each company consults its investment banker to consider alternatives. Market conditions are the following:

• Company C has told its banker that it desires a fixed rate liability.

• Company C is advised that it can probably issue notes in a fixed rate structure at 4.30% or on floating rate terms at LIBOR + 90 bps.

• Company D has told its banker that it desires a floating rate liability.

• Company D is advised to expect a market rate of 4.85% for its fixed rate debt and LIBOR + 150 basis points (bps) for its floating rate debt.

• The banker also checks the swap market on each customer’s behalf. In an email to each customer, the banker notes the best terms in the dealer market on a standard US dollar swap for a 5-year fixed-for-floating swap:

Dealer PAYS 3.28% fixed to customer vs. RECEIVING LIBOR from customer

OR

Dealer RECEIVES 3.32% fixed from customer vs. PAYING LIBOR to customer

The investment banker should advise Company C to
A.   Issue floating-rate debt at LIBOR + 90 bps without doing any swaps.
B.    Issue floating-rate debt at LIBOR+90 and enter a Pay fixed/Receive floating swap
C.    Issue fixed-rate debt at 4.30% and enter a Receive fixed/Pay floating swap
D.   Issue fixed-rate debt at 4.30% without doing any swaps

Explanation / Answer

B.    Issue floating-rate debt at LIBOR+90 and enter a Pay fixed/Receive floating swap

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