Financial Management: Theory & Practice
16th Edition
ISBN: 9781337909730
Author: Brigham
Publisher: Cengage
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Chapter 23, Problem 4P
Summary Introduction
To Determine: Net payments if C and B engage in swap also determine if swap is better option or if it is issued in floating-rate.
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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 7.00%. 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 23 Solutions
Financial Management: Theory & Practice
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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_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_forwardCompany A can borrow money at a fixed rate of 9 percent or a variable rate set at prime plus 1 percent. Company B can borrow money at a variable rate of prime plus 2 percent or a fixed rate of 8.25 percent. Company A prefers a fixed rate and company B prefers a variable rate. A swap dealer can bring them together for a commission of 1% on the swap deal. a) Compute the potential gain for the concerned parties through the swap deal? b) Show a swapping arrangement, ensuring that both Company A and B are better off and the swap dealer gets the 1% cut.arrow_forward
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