Question

​O'Reilly and CB Solutions.  Heather​ O'Reilly, the treasurer of CB​ Solutions, believes interest rates are going to​ rise, so she wants to swap her future​ floating-rate interest payments for fixed rates.​ Presently, she is paying LIBOR +2.00​%per annum on $5,100,000 of debt for the next two​ years, with payments due semiannually. LIBOR is currently 3.98​% per annum. Heather has just made an interest payment​ today, so the next payment is due six months from now. Heather finds that she can swap her current​ floating-rate payments for fixed payments of 7.008​% per annum. ​ (CB Solutions' weighted average cost of capital is 12​%, which Heather calculates to be 6%per​ 6-month period, compounded​ semiannually).

a. If LIBOR rises at the rate of 50 basis points per​ 6-month period, starting​ tomorrow, how much does Heather save or cost her company by making this​ swap?

b. If LIBOR falls at the rate of 25basis points per​ 6-month period, starting​ tomorrow, how much does Heather save or cost her company by making this​ swap?

a. If LIBOR rises at the rate of 50 basis points per​ 6-month period, starting​ tomorrow, how much does Heather save or cost her company by making this​ swap?

The swap (cost/savings) for the first​ six-month period is ​$___. (Select from the​ drop-down menu and round to the nearest​ dollar.)

The swap (cost/savings) for the second​ six-month period is ​$___. (Select from the​ drop-down menu and round to the nearest​ dollar.)

The swap (cost/savings) for the third​ six-month period is ​$___.(Select from the​ drop-down menu and round to the nearest​ dollar.)

The swap (cost/savings) for the fourth​ six-month period is $___.​(Select from the​ drop-down menu and round to the nearest​ dollar.)

b. If LIBOR falls at the rate of 25basis points per​ 6-month period, starting​ tomorrow, how much does Heather save or cost her company by making this​ swap?

The swap (cost/savings) for the first​ six-month period is $___.(Select from the​ drop-down menu and round to the nearest​ dollar.)

The swap (cost/savings) for the second​ six-month period is ​$___. ​(Select from the​ drop-down menu and round to the nearest​ dollar.)

The swap (cost/savings) for the third​ six-month period is $___. (Select from the​ drop-down menu and round to the nearest​ dollar.)

The swap (cost/savings) for the fourth​ six-month period is ​$___. ​(Select from the​ drop-down menu and round to the nearest​ dollar.)

Answer 1

Solution to part A: If LIBOR rises at the rate of 50 basis points per​ 6-month period

In statement it is stated that for each 6-month period LIBOR rises by 50 basis points, so each 6-month period floating rate rises by 50 basis points

i) Floating rate = LIBOR+2% = 4.48%+2% = 6.48% per annum

Floating rate = 3.24% per​ 6-month period

Fixed rate = 7.008% per annum = 3.504% per​ 6-month period

Outflow under fixed rate of interest : $178,704 ($5,100,000*3.504%)

Inflow under floating rate of interest : $165,240 ($5,100,000*3.24%)

The swap cost for the first​ six-month period is ​$13,464

ii) Floating rate = LIBOR+2% = 4.98%+2% = 6.98% per annum

Floating rate = 3.49% per​ 6-month period

Fixed rate = 7.008% per annum = 3.504% per​ 6-month period

Outflow under fixed rate of interest : $178,704 ($5,100,000*3.504%)

Inflow under floating rate of interest : $177,990 ($5,100,000*3.49%)

The swap cost for the second​ six-month period is ​$714

iii) Floating rate = LIBOR+2% = 5.48%+2% = 7.48% per annum

Floating rate = 3.74% per​ 6-month period

Fixed rate = 7.008% per annum = 3.504% per​ 6-month period

Outflow under fixed rate of interest : $178,704 ($5,100,000*3.504%)

Inflow under floating rate of interest : $190,740 ($5,100,000*3.74%)

The swap savings for the third​ six-month period is ​$12,036

iv) Floating rate = LIBOR+2% = 5.98%+2% = 7.98% per annum

Floating rate = 3.99% per​ 6-month period

Fixed rate = 7.008% per annum = 3.504% per​ 6-month period

Outflow under fixed rate of interest : $178,704 ($5,100,000*3.504%)

Inflow under floating rate of interest : $203,490 ($5,100,000*3.99%)

The swap savings for the fourth six-month period is ​$24,786

Solution to part B: If LIBOR falls at the rate of 25basis points per​ 6-month period

In statement it is stated that for each 6-month period LIBOR falls by 25 basis points, so that each 6-month period floating rate falls by 25 basis points

i) Floating rate = LIBOR+2% = 3.73%+2% = 5.73% per annum

Floating rate = 2.865% per​ 6-month period

Fixed rate = 7.008% per annum = 3.504% per​ 6-month period

  Outflow under fixed rate of interest : $178,704 ($5,100,000*3.504%)

Inflow under floating rate of interest : $146,115 ($5,100,000*2.865%)

The swap cost for the first​ six-month period is ​$32,589

ii) Floating rate = LIBOR+2% = 3.48%+2% = 5.48% per annum

Floating rate = 2.74% per​ 6-month period

Fixed rate = 7.008% per annum = 3.504% per​ 6-month period

Outflow under fixed rate of interest : $178,704 ($5,100,000*3.504%)

Inflow under floating rate of interest : $139,740 ($5,100,000*2.74%)

The swap cost for the second​ six-month period is ​$38,964

iii) Floating rate = LIBOR+2% = 3.23%+2% = 5.23% per annum

Floating rate = 2.615% per​ 6-month period

Fixed rate = 7.008% per annum = 3.504% per​ 6-month period

Outflow under fixed rate of interest : $178,704 ($5,100,000*3.504%)

Inflow under floating rate of interest : $133,365 ($5,100,000*2.615%)

The swap cost for the third​ six-month period is ​$45,339

iv) Floating rate = LIBOR+2% = 2.98%+2% = 4.98% per annum

Floating rate = 2.49% per​ 6-month period

Fixed rate = 7.008% per annum = 3.504% per​ 6-month period

Outflow under fixed rate of interest : $178,704 ($5,100,000*3.504%)

Inflow under floating rate of interest : $126,990 ($5,100,000*2.49%

The swap cost for the fourth six-month period is ​$51,714