Question

Company A is considering two fixed interest long-term debt options: a) borrowing at a fixed rate of 3.5% or b) borrowing at a floating rate of Libor + 0.5% and entering a fixed-for-floating swap at 3.25% for Libor. Which option should the company take? How much interest would the company pay for option b) on a $10 million loan (and swap) at the end of the first year if Libor tuns out to be 2.9%?

Answer 1

Answer(1)

Under Option-a the total interest expeses will be 3.5%

Under Option-b, if the company enters ino Fixed for Floating swat at 3.25% for LIBOR, the the cost will be=

=LIBOR +0.5%

=3.25%+0.5% = 3.75%.

Hence the company -A should choose option-a, as the interest will be less in option-a

Answer-(2)

Swap is = FIXED FOR FLOATING.

Means Pay fixed receive floating.

Under option-b , the Company will borrow $ 10 million and will enter into swap option, under which he will pay fixed interest Of LIBOR 3.25% +0.25% = 3.75%

the other swap party will give to company A , LIBOR floating+0.5% =2.9% +0.5% = 3.4%

Company A will collect the 3.4% from the opther swap party and will give to its bank as interest

Similarly Other swap party will collect 3.75% interest from the Company A and will give to its bank as interest.

hence Interest to be paid by Company A = $10 Million*3.75% = $0.375 million or $375000