Dog's can borrow money at either a fixed rate of 8.25 percent or a variable rate set at prime plus 0.5 percent.Cat's can borrow money at either a variable rate of prime plus 1 percent or a fixed rate of 8 percent.Dog's prefers a fixed rate and Cat's prefers a variable rate.Given this information,which one of the following statements is correct?
A)After a swap with Cat's, Dog's could end up paying a fixed rate of 7.8 percent.
B)Cat's should end up paying the prime rate if it agrees to an interest rate swap with Dog's.
C)Both firms will profit if they swap an 8.15 percent fixed rate for a prime plus 0.75 percent variable rate.
D)Dog's will end up paying no more than 7.75 percent as a fixed rate after a swap with Cat's.
E)Dog's and Cat's cannot swap interest rates in a manner that will be profitable for both firms.

Question

Quizplus · Accepted Answer

If Dog's swap its fixed rate of 8.25% for Cat's variable rate of prime plus 1%, it would end up paying a rate of prime plus 0.5%, which is lower than its initial fixed rate. Similarly, if Cat's swap its variable rate of prime plus 1% for Dog's fixed rate of 8.25%, it would end up paying a fixed rate of 8%, which is lower than its initial variable rate.

The statement in option A is incorrect as it suggests Dog's would end up paying a fixed rate lower than the original 8.25%, which is unlikely.

The statement in option B is incorrect because if Cat's agrees to an interest rate swap with Dog's, it may end up paying a fixed rate higher than the prime rate.

The statement in option D is incorrect as it suggests Dog's would end up paying a fixed rate lower than 7.75%, which is unlikely.

Option E is incorrect as a profitable interest rate swap can be conducted between the two firms, as shown in option C.

Dog's Can Borrow Money at Either a Fixed Rate of 8.25