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.