Assume that Fed Ex is planning to issue $100,000,000 of 270-day commercial paper

Question

Assume that Fed Ex is planning to issue $100,000,000 of 270-day commercial paper for an effective yield of 4.75 percent. Trough Credit Enhancement, FedEx expects to save 30 basis on the interest rate by using either a Standby Letter of Credit (SLC) or a loan commitment (LC) as collateral enhancement for the issue. What are the net savings to the corporation if a bank agrees to provide a 270-day SLC for an up-front of 19 basis points on the total value to back the commercial paper issue? What are the net savings to the corporation if a bank agrees to provide a 270-day loan commitment to back the commercial paper issue? The bank will charge 10 basis points for an up-front fee and 8 basis points for a back-end fee for any unused portion of the loan. Assume the loan is not needed. Which, if any of the credit enhancement methods should FedEx use?

Explanation / Answer

a. The commercial paper is issued at 4.75% effective yield for 270 day period

Now the firm ill save 30 basis points by SLC (standby letter of credit). 30 basis point is 0.30%

So the effective savings = 4.75 - 0.30 = 4.45%

Now the bank charges 19 basis point or 0.19%. So the effetcive rate of bank = 4.45 + 0.19 = 4.64%

Hence the savings for the corporation is 4.75% - 4.64% = 0.11% or 11 basis points

Hence the total savings = 0.11% of 100,000,000 = $110,000

b. Now the total fee charged by the bank is 10 basis points + 8 basis points (for unused loan) for the LC (loan commitment). We use the 8 basis points since the loan is assumed to be not needed.

Hence savings here is 30 -18 = 12 basis point or 0.12%

Hence Hence the total savings = 0.12% of 100,000,000 = $120,000

c. The LC (loan commitment) - Option b is better as it gives a higher savings to the corporation

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