Intermediate Financial Management
14th Edition
ISBN: 9780357516782
Author: Brigham, Eugene F., Daves, Phillip R.
Publisher: Cengage Learning
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Chapter 24, Problem 4P
Summary Introduction
To determine: The net payments when person C and person B engage in swap and which is better option for person C and person B.
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Carter Enterprises can issue floating-rate debt at LIBOR + 2% or fixed-ratedebt at 10%. Brence Manufacturing can issue floating-rate debt at LIBOR +3.1% or fixed-rate debt at 11%. Suppose Carter issues floating-rate debt andBrence issues fixed-rate debt. They are considering a swap in which Cartermakes a fixed-rate payment of 7.95% to Brence and Brence makes a payment of LIBOR to Carter. What are the net payments of Carter and Brence ifthey engage in the swap? Would Carter be better off if it issued fixed-ratedebt or if it issued floating-rate debt and engaged in the swap? Would Brencebe better off if it issued floating-rate debt or if it issued fixed-rate debt andengaged in the swap? Explain your answers.
Swaps
Carter Enterprises can issue floating-rate debt at LIBOR + 1% or fixed-rate debt at 9%. Brence Manufacturing can issue floating-rate debt at LIBOR +3.4% or
fixed-rate debt at 12%. Suppose Carter issues floating-rate debt and Brence issues fixed-rate debt. They are considering a swap in which Carter makes a fixed-
rate payment of 8.85% to Brence and Brence makes a payment of LIBOR to Carter. What are the net payments of Carter and Brence if they engage in the
swap? Round your answers to two decimal places. Use a minus sign to enter negative values, if any.
Net payment of Carter: 8.60
%
Net payment of Brence: -(LIBOR +
0.40
%)
Would Carter be better off if it issued fixed-rate debt or if it issued floating-rate debt and engaged in the swap?
The swap is good for Carter, if it issued fixed-rate debt
Would Brence be better off if it issued floating-rate debt or if it issued ed-rate debt and engaged in the swap?
ed-
The swap is good for Brence, if it issued fixed-rate debt and engaged…
Zhao Automotive issues fixed rate debt at a rate of 7.0%. Zhao agrees to an interest rate swap in which it pays LIBOR to Lee Financial and Lee pays 6.8% to Zhao. What is Zhao’s resulting net payment?
Chapter 24 Solutions
Intermediate Financial Management
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- Suppose that Phoenix bank seeks to reduce its interest rate risk in regards to its holdings of fixed-rate (10%) mortgages via the use of interest rate swaps. To this end, Phoenix and Epitome bank come to an agreement of a swap arrangement, whereby Epitome receives fixed-rate payments from Phoenix's mortgages, equaling 8%. In exchange, Phoenix receives variable payments from Epitome, equaling the LIBOR rate (the interbank lending rate for Eurobanks). Assume that Phoenix's cost of funds (or the rate owed on its deposits) is equal to the LIBOR rate, less 1%. The following table details the swap arrangement from the point of view of Phoenix bank for various possible values of LIBOR. Possible Future LIBOR Rates Unhedged Strategy 7% 8% 9% 10% 11% 12% Average rate on existing mortgages 10% 10% 10% 10% 10% 10% Average cost of deposits 5 6 7 8 9 10 Spread 5 4 3 2 1 0 Hedging with Interest Rate Swap Fixed interest earned on fixed-rate mortgages 10% 10% 10% 10% 10% 10% Fixed interest owed on swap…arrow_forwardMessman Corporation issues fixed-rate debt at a rate of 9.00%.Messman agrees to an interest rate swap in which it pays LIBOR toMoore Inc. and Moore pays 8.75% to Messman. What is Messman’sresulting net payment? (LIBOR 1 0.25%arrow_forwardTwo companies, Company A and Company B, are looking to enter into an interest rate swap agreement. Company A Company B Fixed rate 5% 6% Floating Rate 3-month LIBOR plus 1% 3-month LIBOR plus 1.5% Suppose that company A requires a floating-rate borrowing and company B requires a fixed- rating borrowing. A financial institution is planning to arrange a swap and requires 20bps spread. If benefits are equally shared both companies, what rate of interest will A and B pay?arrow_forward
- DEFS Company issues 5% long term debt and engages with FEDS Company in an interest rate swap. In exchange for LIBOR, FEDS will pay 4.5% to DEFS. If the LIBOR is presently 3%, and DEFS CAPM is 6%, what is DEFS net payment? your answer should look like this 4.5 that is not the right answerarrow_forward(Following Rates are Quoted) Company A Company B Credit Rating A B Fixed Rate 6% 8% Floating Rate LIBOR+1% LIBOR+1.5% Which company has a relative advantage and in which market? Which company has an absolute advantage and in which market Company A wants to borrow floating. Company B wants to borrow fix. Build a proper SWAP that benefit the two companies.arrow_forwardCompany A and B has been offered the following rates per annum on a £10 million 5 - year loan. Company A Fixed (%) Floating (%) LIBOR + 1.2 B LIBOR + 0.3 Company A requires a floating rate loan, whereas company B requires a fixed rate loan. In which market does company A have a comparative advantage? Design a swap that will give a bank, acting as an intermediary 0.5% p.a. and that will appear equally attractive to both companies. Explain how to achieve this, using diagrams and text.arrow_forward
- 15. The table below presents the costs of borrowing for Caterpillar and Tesla, and the a Swap Bank quote against LIBOR. Caterpillar would like to get a $5,000,000.00 floating rate loan. Tesla would like to get a $5,000,000.00 fixed rate loan. How much can Tesla save each year by entering a swap agreement? (a) $37,000 (b) $9,500 (c) $8,000 (d) $27,500 Fixed-Rate Borrowing Cost Floating-Rate Borrowing Cost Caterpillar Tesla 3.00 6.50 LIBOR LIBOR +2.60 Swap Bank Quote Bid Ask 3.19% 3.74% (e) None of the abovearrow_forwardCompanies A and B want to borrow €10 million each (they want to issue debt) for years. The market offers them the following alternatives (Symbol for floating rate: L). Company A) Floating rate: L + 1.5%, Fix rate: 2.0%. Company B) Floating rate: L+ 3.0%, Fix rate: 5.0%. A financial institution arranges a swap and charges 10 basis points (0.1%) per year. If the swap is organized so that it is equally attractive to both companies: What is the net rate of interest that will end up paying company A and Barrow_forwardSuppose that at the present time, one can enter 5-year swaps that exchange LIBOR for 5%. An off-market swap would then be defined as a swap of LIBOR for a fixed rate other than 5%. For example, a firm with 11% coupon debt outstanding might like to convert to synthetic floating-rate debt by entering a swap in which it pays LIBOR and receives a fixed rate of 11%. What up-front payment will be required to induce a counterparty to take the other side of this swap? Assume notional principal is $95 million. (Do not round intermediate calculations. Round your final answer to the nearest dollar amount.)arrow_forward
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