A corporation has issued a $14 million issue of floating-rate bonds on which it

Question

A corporation has issued a $14 million issue of floating-rate bonds on which it pays an interest rate 0.8% over the LIBOR rate. The bonds are selling at par value. The firm is worried that rates are about to rise, and it would like to lock in a fixed interest rate on its borrowings. The firm sees that dealers in the swap market are offering swaps of LIBOR for 7%. A swap arrangement converts the firm’s borrowings to a synthetic fixed-rate loan. What interest rate will it pay on that synthetic fixed-rate loan? (Round your answer to 1 decimal place.)

Explanation / Answer

The corporation should enter a swap in which it pays a 7% fixed rate and receives LIBOR on $14 million of notional principal. The total payment will be as follows:

Interest payments on bond --- ---- (LIBOR + 0.008) x $14 million par value

Net cash flow from swap ---------(0.07 – LIBOR) x $14 million notional principal

Summing both of them up
We get fixed loan rate = 0.07+0.008=0.078 or 7.8%

Hence answer is 7.8%

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.