Company A, a lower-rated firm, desires a fixed-rate long-term loan. Company A pr

Question

Company A, a lower-rated firm, desires a fixed-rate long-term loan. Company A presently has access to floating interest rate funds at a margin of 1.2% over LIBOR. In contrast, company B, a higher-rated firm, prefers a floating-rate loan. Company B has access to fixed-rate funds at 10.5% and floating-rate funds at LIBOR+0.7%. Both companies enter into an interest rate swap with Bank C. Based on the swap, Bank C would gain 0.2% and each of the two companies would gain 0.5%. What is the current fixed rate available for Company A?

Select one:

a. 12.9%

b. 13.4%

c. 12.2%

d. 8.8%

e. 11.8%

f. 9.6%

Explanation / Answer

ANSWER = C) 12.2%

Bank C would gain= 0.2%

Gain to both companies = 0.5%

Total gain of companies = 1%

Difference between fixed and floating rate = Bank gain + companies gain

= 0.2% + 1% = 1.2%

The difference between fixed and floating rate is

.X- 10.5% - .5% = 1.2%

= X-10% = 1.2%

X = 12.2%

Proof

Fixed

A

12.2%

Libor +1.2%

B

10.5%

Libor +0.7%

Difference

1.7%

.5%

The difference between fixed and floating rate = 1.7 - .5% = 1.2%

Less- gain to bank C = .2%

Gain After distribution to C = 1%

Share equally = 1% / 2 = 0.5% each

Fixed

A

12.2%

Libor +1.2%

B

10.5%

Libor +0.7%

Difference

1.7%

.5%

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