Smith Brothers has a floating-rate loan based on the LIBOR rate. The Three Sisters has a floating-rate loan based on the Treasury bill. The Smith Brothers would prefer a loan based on the T-bill and the Three Sisters would prefer a loan based on LIBOR, but neither have been able to obtain the loan they prefer. These two firms would most likely benefit if they entered a(n):
A) Forward contract on the dollar-pound exchange rate.
B) Commodity swap.
C) Exchange rate swap.
D) Interest rate swap.
E) Futures contract on the dollar-pound exchange rate.

Question

Quizplus · Accepted Answer

An interest rate swap would allow Smith Brothers and The Three Sisters to exchange their interest rate payment obligations, effectively allowing each to benefit from the preferred interest rate basis (LIBOR for The Three Sisters and T-bill for Smith Brothers) without changing the original terms of their loans with their respective lenders.

Smith Brothers Has a Floating-Rate Loan Based on the LIBOR