A firm can borrow at a floating rate of LIBOR + 2.5% on short-term loans.If it swaps its short-term payments so that it receives LIBOR + 1.25% and pays a fixed rate of 3.75%,what is the rate of interest on its borrowing?
A)5.00%
B)3.75%
C)7.50%
D)2.50%
E)1.25%

Question

Quizplus · Accepted Answer

The firm initially borrows at LIBOR + 2.5%. Through the swap, it pays a fixed rate of 3.75% and receives LIBOR + 1.25%. The net effect is that it pays 3.75% - (LIBOR + 1.25%) + (LIBOR + 2.5%), simplifying to 3.75% + 1.25% = 5.00%.

A Firm Can Borrow at a Floating Rate of LIBOR