5. Spalding Finance Inc. can borrow at a fixed rate of 10% or at LIBOR-50 basis

Question

5. Spalding Finance Inc. can borrow at a fixed rate of 10% or at LIBOR-50 basis points. Jamaica Manufacturing can borrow at a fixed rate of 13% or at LIBOR+100 basis points.

a. Suppose Spalding Finance prefers a floating rate loan while Jamaica Manufacturing prefers a fixed rate loan. Is there a mutually advantageous opportunity to engage in an interest rate swap? Briefly explain.

b. Jamaica Manufacturing proposes to pay 10.8% in return for LIBOR+0. What is the cost of borrowing for Spalding and Jamaica after the swap?

c. What is the cost saving that each party realizes under the swap terms in part b.?

Explanation / Answer

savings over issuing floating-rate debt on its own

Jamaica Manufacturing’s fixed-rate all-in-cost is:

LIBOR+ 1% + 10.80% - LIBOR = 11.80%,

a .1.3% savings over issuing fixed-rate debt

A Spalding Finance floating rate at LIBOR-50 basis points Jamaica Manufacturing fixed rate 13% Companies can sometimes receive either a fixed- or floating-rate loan at a better rate than most other borrowers. However, that may not be the kind of financing they are looking for in a particular situation. A company may, for example, have access to a loan with a 13% rate when the current rate is about 14%. But they may need a loan that charges a floating rate payment. If another company, meanwhile, can gain from receiving a floating rate interest loan, but is required to take a loan that obligates them to make fixed payments, then two companies could conduct a swap, where they would both be able to fulfill their respective preferences. if LIBOR RATE IS 12% Than floating rate will be 12-.5 11.50% Jamaica Manufacturing will advantage position for taking swap by (13-11.5)=0.5% if LIBOR RATE IS 14% Than floating rate will be 14-.5 = 13.50% Spalding Financewill advantage position for taking swap by (13.5-13)=0.5% B Jamaica Manufacturing proposes to pay 10.8% in return for LIBOR+0 cost to Spalding Finance 10% + LIBOR-50 basis points-10.8% =LIBOR -1.3 % 1.30%

savings over issuing floating-rate debt on its own

c

Jamaica Manufacturing’s fixed-rate all-in-cost is:

LIBOR+ 1% + 10.80% - LIBOR = 11.80%,

a .1.3% savings over issuing fixed-rate debt

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