Company A desires a fixed-rate, long-term loan. Company A presently has access t

Question

Company A desires a fixed-rate, long-term loan. Company A presently has access to floating interest rate funds at a margin of 1.5% over LIBOR. Its direct borrowing cost is 13% in the fixed-rate bond market. In contrast, company B, which prefers a floating-rate loan, has access to fixed-rate funds at 10.5% and floating-rate funds at LIBOR+1%. Both companies enter into an interest rate swap with Bank C. Based on the swap, Bank C would gain 0.6% and the two companies would split the remaining spread differential equally. With the swap deal, what interest rate would Company B pay for its floating-rate funds?

Select one:

a. LIBOR+.7%

b. LIBOR+.3%

c. LIBOR+1.5%

d. LIBOR+1.2%

e. LIBOR-1%

f. LIBOR-.6%

Explanation / Answer

Fixed

Floating

A

13%

Libor +1.5%

B

10.5%

Libor +1%

Difference

2.5%

.5%

The difference between fixed and floating rate is 2.5%-.5%=2%.

Gain to C = 0.6%

Balance = 1.4%

A and B will split this 1.4% and each will receive saving cost of 0.7%.

Below are the details:

A will borrow Libor+1.5% and then enter a swap with C in which A will pay a fixed rate of 12.3% (13%-.7%) and receive Libor+1.5%.

Cost for A = (Libor+1.5%) +12.3 % - ( Libor+1.5%) =12.3%

B will borrow at 10.5% then enter the swap with C in which B will pay C a floating rate Libor+.3% and

Cost for B: 10.5 %+( Libor+0.3%)-10.5%

=Libor + .3%

ANSWER = B) LIBOR+.3%

Fixed

Floating

A

13%

Libor +1.5%

B

10.5%

Libor +1%

Difference

2.5%

.5%

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