Firm a Can Borrow at 4% Fixed or in the Floating-Rate

question 31

Multiple Choice

Firm A can borrow at 4% fixed or in the floating-rate market at Libor flat. Firm B can borrow at 7% fixed or at Libor $+ 100$ bps. A wants to borrow floating and B fixed. Suppose that to reduce financing costs, A borrows fixed, B borrows floating, and they enter into an interest-rate swap. Which of the following statements is valid?

• A) The combined improvement in cost of financing to A and B with the swap is always equal to the difference between the fixed rate differential (between A and B) and the floating rate differential which in this case is 200 basis points.
• B) The combined improvement in cost of financing to A and B with the swap is always equal to the floating rate differential, which in this case is 100 basis points.
• C) The combined improvement in cost of financing to A and B with the swap depends on the negotiated fixed rate on the swap between the two counterparties.
• D) No improvement in combined financing costs is possible-what one party gains in financing costs, the other party loses.

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Definitions:

Minerals Below

Refers to subsurface rights pertaining to minerals like oil, gas, coal, and others that lie beneath the surface of a piece of land.

Public Nuisance

An act or condition that is harmful or annoying to the public in general, significantly interfering with the enjoyment of public rights.

Landowners

Individuals or entities that have legal title to a piece of land, owning either the surface rights, subsurface rights, or both.

Warranty Deed

A deed that guarantees a clear title to the purchaser of real property.