Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown here: $$\begin{array} { c c c }
& \text { Fixed-Rate } & \text { Floating-Rate } \
&\text { Borrowing Cost } & \text { Bortowing Cost } \
\text { Compary X } & 10 \% & \text { LIBOR } \
\text { Compary Y } & 12 \% & \text { LIBOR } + 1.5 \%
\end{array}$$ A swap bank proposes the following interest only swap:
Y will pay the swap bank annual payments on $10,000,000 with a fixed rate of rate of 9.90 percent.In exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR ? 0.15 percent; What is the value of this swap to company Y?
A)Company Y will save 15 basis points per year on $10,000,000 = $15,000 per year.
B)Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year.
C)Company Y will save 5 basis points per year on $10,000,000 = $5,000 per year.
D)Company Y will only break even on the deal.

Question

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown here: $$\begin{array} { c c c } 
& \text { Fixed-Rate } & \text { Floating-Rate } \
&\text { Borrowing Cost } & \text { Bortowing Cost } \
\text { Compary X } & 10 \% & \text { LIBOR } \
\text { Compary Y } & 12 \% & \text { LIBOR } + 1.5 \%
\end{array}$$ A swap bank proposes the following interest only swap:
Y will pay the swap bank annual payments on $10,000,000 with a fixed rate of rate of 9.90 percent.In exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR ? 0.15 percent; What is the value of this swap to company Y?
A)Company Y will save 15 basis points per year on $10,000,000 = $15,000 per year.
B)Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year.
C)Company Y will save 5 basis points per year on $10,000,000 = $5,000 per year.
D)Company Y will only break even on the deal.

Quizplus · Accepted Answer

Without the swap, Company Y would have to borrow $10,000,000 at a fixed rate of 12%, which would be an annual interest payment of $1,200,000.

With the swap, Company Y can borrow the $10,000,000 at a floating rate (LIBOR + 1.5%) and then pay the swap bank a fixed rate of 9.9%. The swap bank will pay Company Y the floating rate (LIBOR - 0.15%).

Assuming LIBOR is currently 2.5%, Company Y would pay the swap bank a fixed rate of 9.9% and receive LIBOR - 0.15%, or a net rate of 2.35%. The annual interest payment would be $235,000.

Compared to the original fixed rate borrowing of $1,200,000, the swap allows Company Y to save $965,000 per year. This represents a savings of 80 basis points (0.8%) on the $10,000,000 principal. Therefore, the correct answer is B.

Company X Wants to Borrow $10,000,000 Floating for 5 Years;