Asked by Kaylie Katsiris on Jun 15, 2024
Verified
Company A can issue floating-rate debt at LIBOR + 1%,and it can issue fixed rate debt at 9%.Company B can issue floating-rate debt at LIBOR + 1.5%,and it can issue fixed-rate debt at 9.4%.Suppose A issues floating-rate debt and B issues fixed-rate debt,after which they engage in the following swap: A will make a fixed 7.95% payment to B,and B will make a floating-rate payment equal to LIBOR to A.What are the resulting net payments of A and B?
A) A pays a fixed rate of 9%; B pays LIBOR + 1.5%.
B) A pays a fixed rate of 8.95%; B pays LIBOR + 1.45%.
C) A pays LIBOR plus 1%; B pays a fixed rate of 9.4%.
D) A pays a fixed rate of 7.95%; B pays LIBOR.
LIBOR
London Interbank Offered Rate; the rate that large banks in London charge one another.
Floating-Rate Debt
A type of debt instrument with interest rates that adjust periodically based on a benchmark interest rate or index.
Fixed Rate Debt
A type of loan or security with an interest rate that remains constant throughout the life of the loan or security.
- Ascertain approaches to mitigate the impact of interest rate variability.
- Acquire knowledge on the framework and contrasting features of diverse financial instruments relative to credit default swaps.
Verified Answer
SS
SABAHAT SHAHIDJun 18, 2024
Final Answer :
B
Explanation :
A's original cost is LIBOR + 1%. After the swap, A pays 7.95% fixed to B and receives LIBOR from B, effectively paying 7.95% fixed. B's original cost is 9.4% fixed. After the swap, B pays LIBOR to A and receives 7.95% fixed from A, effectively paying 9.4% - 7.95% = 1.45% over LIBOR, or LIBOR + 1.45%.
Learning Objectives
- Ascertain approaches to mitigate the impact of interest rate variability.
- Acquire knowledge on the framework and contrasting features of diverse financial instruments relative to credit default swaps.
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