A company has issued floating-rate notes with a maturity of one year, an interes

Question

A company has issued floating-rate notes with a maturity of one year, an interest rate of LIBOR plus 125 basis points, and total face value of $50 million. The company now believes that interest rates will rise and wishes to protect itself by entering into an interest rate swap. A dealer provides a quote on a swap in which the company will pay a fixed rate 6.5 percent and receive LIBOR. Interest is paid quarterly, and the current LIBOR is 5 percent. Show all your calculations and explain in details.

(a) Indicate how the company can use a swap to convert the debt to a fixed rate.

Explanation / Answer

The present interest that the company pays is LIBOR + 125 basis point = 5 + 1.25 = 6.25% interest rate

Now if the interest rates increase by more than 25 basis points, the swap will benefit the company

1. If the interest rate rise by 25 basis point, there is no benefit for the company

2. If the interest rate rises by 50 basis point and becomes, 5.5%, The the company benefits 0.25% or 25 basis points (5.5+1.25 -6.5)

3. If the interest rate rises by 75 basis point and becomes, 5.75%, The the company benefits 0.50% or 50 basis points (5.5+1.25 -6.5)

4. If the interest rate rises by 100 basis point and becomes, 6.00%, The the company benefits 0.75% or 75 basis points (6+1.25 -6.5)

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

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