Company X Wants to Borrow $10,000,000 Floating for 5 Years;

question 11

Multiple Choice

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown below: $$\begin{array} { l l l } & \begin{array} { l } \text { Fixed-Rate } \\\text { Borrowing Cost }\end{array} & \begin{array} { l } \text { Floating-Rate } \\\text { Borrowing Cost }\end{array} \\\hline \text { Company X } & 10 \% & \text { LIBOR } \\\text { Company Y } & 12 \% & \text { LIBOR } + 1.5 \%\end{array}$$ A swap bank proposes the following interest only swap: Y will pay the swap bank annual payments on $10,000,000 with a fixed rate of 9.90%.In exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR - 0.15%; What is the value of this swap to company Y?

• A)Company Y will save 15 basis points per year on $10,000,000 = $15,000 per year.
• B)Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year.
• C)Company Y will save 5 basis points per year on $10,000,000 = $5,000 per year.
• D)Company Y will only break even on the deal.

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Definitions:

Deposit

Funds placed into a financial institution for safekeeping, often to accrue interest over time; could also refer to a payment made in advance as a commitment or partial payment.

Retirement Savings Plan (RSP)

A financial arrangement designed to help individuals save for their retirement.

Investments

Financial assets purchased with the expectation that they will generate income and/or appreciate in the future.

Compounded Annually

Calculating interest on the initial principal, which includes any accumulated interest from previous periods, once per year.