Question

1. It costs NFLX 3.50% to borrow in the fixed rate market and 3mLIBOR +.25% to borrow in the floating rate markets for 2 years. The two year swap rate is quoted at 3.15%. If the NFLX were to use the swap market to lower their fixed rate borrowing costs how would they go about it and much would they save in annual interest rate expense?

1. Borrow in the fixed rate market, receive on a 2-year swap and save .05%.
2. Borrow in the floating market, pay on a 2-year swap and save .10%
3. Borrow in the fixed market, pay on a 2-year swap and save .20%
4. Borrow in the floating market, receive on a 2-year swap and save .20%.

Answer 1

NFLX wants to lower their fixed rate borrowing costs. This means NFLX wants to borrow fixed.

To maximize the profit, company NFLX will borrow at variable rate. Thereafter it will enter into a Swap where NFLX will pay variable and receive fixed rate.

Interest rate without the swap is 3.5%.

Calculation of Interest rate with the swap :

Company A will borrow at Libor + 0.25%

After this it will enter into a swap, paying 3m Libor and receiving fixed.
Inflow = Libor
Outflow = 3.15%

Net Outflow for NFLX with swap option = Libor + 0.25% - Libor + 3.15%
                                                              = 3.40%

Savings in annual interest rate option because of Swap = Total Interest Rate without Swap – Total Interest Rate with Swap

                                    = 3.50% - 3.40%

                                    = 0.10%

Option b. is correct. Borrow in the floating market, pay on a 2-year swap and save 0.10%