Company A, a low-rated firm, desires a fixed-rate, long-term loan. Company A pre

Question

Company A, a low-rated firm, 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 11% and floating-rate funds at LIBOR+0.5%. Suppose both companies enter into an interest rate swap and split the spread differential; that is, they share the spread differential equally. With the swap deal, what interest rate would Company B pay for its floating-rate funds? Note: You can just assume that both companies enter into the swap directly with each other without going through a bank, or you can assume that they go through a bank but the gain to the bank is zero. Select one: a. LIBOR+.5% b. LIBOR+.2% c. LIBOR-.02% d. LIBOR+0%

Explanation / Answer

1. Answer (B) LIBOR +.2%

   Explanation : B company Borrows at 11%

                           Receives from A Company     (11.2%)     (11+(0.13-0.11)

                              Pays to A companu           LIBOR

                             Net Interest cost                  LIBOR +0.2% ( A savings of 0.3%)

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