Dog's can borrow money at either a fixed rate of 8.25 percent or a variable rate set at prime plus .5 percent. Cat's can borrow money at a variable rate of prime plus 1 percent or a fixed rate of 8 percent. Dog's prefers a fixed rate and Cat's prefers a variable rate. Given this information, which one of the following statements is correct?
A) After a swap with Cat's, Dog's could end up paying a fixed rate of 7.8 percent.
B) Cat's should end up paying the prime rate if it agrees to an interest rate swap with Dog's.
C) Both firms will profit if they swap an 8.15 percent fixed rate for a prime plus .75 percent variable rate.
D) Dog's will end up paying no more than 7.75 percent as a fixed rate after a swap with Cat's.
E) Dog's and Cat's cannot swap interest rates in a manner that will be profitable for both firms.

Question

Quizplus · Accepted Answer

Both firms can benefit from a swap where Dog's pays a slightly lower fixed rate than its original 8.25% and Cat's pays a slightly lower variable rate than its original prime plus 1%.

Dog's Can Borrow Money at Either a Fixed Rate of 8.25