The following statement is to be used in answering questions
Company X, a low rated firm, desires a fixed rate, long term loan. X presently has access to floating interest rate funds at a margin of 1.25% over LIBOR. Its direct borrowing cost is 11% in the fixed rate bond market. In contrast, company Y, which prefers a floating rate loan, has access to fixed rate funds in the Eurodollar bond market at 9% and floating rate funds at LIBOR + 1/4%. Suppose they split the cost savings.
-much would X pay for its fixed-rate funds?
A) 9.5%
B) 10.0%
C) 10.5%
D) 10.75%

Question

The following statement is to be used in answering questions 
Company X, a low rated firm, desires a fixed rate, long term loan. X presently has access to floating interest rate funds at a margin of 1.25% over LIBOR. Its direct borrowing cost is 11% in the fixed rate bond market. In contrast, company Y, which prefers a floating rate loan, has access to fixed rate funds in the Eurodollar bond market at 9% and floating rate funds at LIBOR + 1/4%. Suppose they split the cost savings.
-much would X pay for its fixed-rate funds?
A) 9.5%
B) 10.0%
C) 10.5%
D) 10.75%

Quizplus · Accepted Answer

Company X and Y can engage in an interest rate swap to reduce their borrowing costs. The difference in fixed rates is 2% (11% - 9%), and the difference in floating rates is 1% (1.25% - 0.25%). The total potential savings is 1% (2% - 1%). If they split the savings equally, each saves 0.5%. Therefore, X's effective fixed rate would be 11% - 0.5% = 10.5%.

The Following Statement Is to Be Used in Answering Questions