ABC Company issued fixed rate bond at 9% p.a. and XYZ Company issued floating-rate bond at...

ABC Company issued fixed rate bond at 9% p.a. and XYZ Company issued floating-rate bond at LIBOR + 2%. The two companies enter an interest rate swap agreement that ABC Company agreed to provide XYZ Company with variable rate payments at LIBOR + 0.5% in exchange for fixed rate payments of 10%.

(a) Explain how the bond issued by ABC Company affects its interest rate risk.

(b) Calculate the effective borrowing rates of ABC Company and XYZ Company respectively after considering interest rate swap.

(c) Identify and explain briefly ONE limitation of using interest rate swap to hedge interest rate risk.

Expert Solution

C) Limitation of using Interest rate swap :

Exposed to credit risk as either one or either both the parties could default on the interest payments on the due dates which creates burden on the other party to pay.

jeff jeffy answered 5 months ago

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