Consider a Plain Vanilla Interest Rate Swap

question 90

Multiple Choice

Consider a plain vanilla interest rate swap.Firm A can borrow at 8 percent fixed or can borrow floating at LIBOR.Firm B is somewhat less creditworthy and can borrow at 10 percent fixed or can borrow floating at LIBOR + 1 percent.Eun wants to borrow floating and Resnick prefers to borrow fixed.Both corporations wish to borrow $10 million for 5 years.Which of the following swaps is mutually beneficial to each party and meets their financing needs?

• A)Firm A borrows $10 million externally for 5 years at LIBOR; agrees to swap LIBOR to firm B for 8 ½ percent fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at 10 percent.
• B)A borrows $10 million externally for 5 years at LIBOR; agrees to pay 8½ percent to B for LIBOR fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at 10 percent.
• C)Since the QSD = 0 there is no mutually beneficial swap.
• D)A borrows $10 million externally at 8 percent fixed for 5 years; agrees to swap LIBOR to B for 8½ percent fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at LIBOR + 1 percent.

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Definitions:

Indirect Labor

The wages paid to employees who support the production process but are not directly involved in the creation of the product or service.

Resource Consumption

The usage of resources by a company or process, including materials, energy, and labor, critical for understanding cost behaviors and environmental impact.

Activity-Based Costing

A costing methodology that assigns costs to products or services based on the activities and resources required to produce or deliver them.

Activity Cost Pools

A technique in managerial accounting where costs are aggregated based upon the activities that generate those costs, to assign costs more accurately.