The CFO of Access Inc., Lee Nussbaum, believes interest rates may rise. At prese

Question

The CFO of Access Inc., Lee Nussbaum, believes interest rates may rise. At present, Access is paying LIBOR + 2.25% per year on $100,000 000 worth of Eurobonds with annual coupon payments and a remaining maturity of three years. LIBOR was hinds that annually he can swap floating LIBOR the next three years. He decides to enter into this interest rate swap to hedge his firm's interest rate 100% peryear for the last year Mr Nussba unm payments with fixed payments of 1 75% per year over just made an interest payment, so the next payment is due one year from today and answer the following questions a. What are Access's interest will be 1.50%) LIBOR rises every year by 0 50% per year (so for Year 1, LIBOR and principal pay ments on its ments on its bonds over the next three years? Year 2 Year 3 Year 1 LIBOR % LIBOR Payment (S) Spread (S) Principal (S) Total (S) Will Access choose to pay-fixed and receive-floating interest payments in the swap or vice versa? Circle one b. PAY FIXEDIRECEIVE FLOATING PAY FLOATING/RECEIVE FIXED c. What should be Access's cash flows on its swap over the next three years (assuming Mr Nussbaum chose a swap with the correct notional principal size)? To answer this question complete the following table Show both the cash flows paid and received Circle+for cash inflows to Access; circle- for cash outflows from Access Year 1 Year 2 Year 3 LIBOR ($ Fixed (S)

Explanation / Answer

Ans a.

Ans b: Pay Fixed/ Receive Floating

The company currently has a floating rate payment obligation, which is negetively affected by increase in LIBOR Rates. To hedge this, the company will enter a swap to receive the floating LIBOR rate and pay fixed rate.

Ans C: To hedge the increasing LIBOR rate payment obligation on $100 million, the company will enter the swap to receive LIBOR on the notional principal of $100 million itself.

Ans D:

Ans e:

Annual Interest rate = Annual interest paid/ Principal value of the bond

= 4250,000/100,000,000 = 4.25%

Details/ Forumla Used Year 1 Year 2 Year 3 LIBOR % Given to be 1.50% for year one and increasing by 0.50% every year 1.50% 2.00% 2.50% LIBOR Payment ($) =LIBOR Rate * Principal Amount 1,500,000 2,000,000 2,500,000 Spread ($) =Spread of 2.25% * Principal Amount 2,500,000 2,500,000 2,500,000 Principal ($) Paid at end of year 3 0 0 100,000,000 Total ($) 4,000,000 4,500,000 105,000,000

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