American Airlines (“AAL”) has a ten-year floating rate loan of $50 million at LI

Question

American Airlines (“AAL”) has a ten-year floating rate loan of $50 million at LIBOR plus 120 basis points from Wells Fargo. The floating interests are paid quarterly. AAL fears a rise in interest rates and hence wants to hedge against rising interest rates using the interest rate swap. AAL approaches to a swap dealer, the Bank of America (“BAC”), and gets the fixed swap rate of 2.1% with the exchange of LIBOR for a ten-year swap contract. The swap payments occur quarterly. The day counting is actual/360 based for both counterparties. Assume that today’s six-month LIBOR is 0.98%. What is the (transformed) interest rate that AAL pays with the combination of the original loans (from Wells Fargo) and the swap (with BAC)?

Less than 1% Greater than 4%

Greater than 1% but less than 2%

Greater than 3% but less than 4%

Greater than 2% but less than 3%

Explanation / Answer

The interest rate that AAL pays on floating loan=LIBOR+1.2%

the net interest that AAL receive under the swap =floating rate receive-fixed rate pay=LIBOR-2.1%

The net interest rate that AAL pays =The interest rate that AAL pays on floating loan-the net interest that AAL receives under the swap

The net interest rate that AAL pays =(LIBOR+1.2%)-(LIBOR-2.1%)

The net interest rate that AAL pays =1.2%+2.1%

The net interest rate that AAL pays =3.3%

Thus the net interest rate that AAL pays =3.3% is Greater than 3% but less than 4%.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.