Murray's can borrow money at a fixed rate of 10.5 percent or a variable rate set at prime plus 2.25 percent. Fred's can borrow money at a variable rate of prime plus 1.5 percent or a fixed rate of 12 percent. Murray's prefers a variable rate and Fred's prefers a fixed rate. Given this information, which one of the following statements is correct?
A) After swapping interest rates with Fred's, Murray's may be able to pay prime plus 2 percent.
B) Both companies can profit in a swap that will allow Murray's to pay a variable rate of prime plus one percent.
C) Fred's will end up with a fixed rate of 10 percent.
D) Fred's has the best chance of profiting if it does a currency swap with Murray's.
E) There are no terms under which Murray's and Fred's can swap interest rates.

Question

Quizplus · Accepted Answer

If Murray's swaps interest rates with Fred's and takes on a fixed rate of 12 percent, Fred's can then borrow at the variable rate of prime plus 2.25 percent. If Murray's can borrow money at prime plus 2 percent, then it can save 0.25 percent compared to its fixed rate of 10.5 percent, so it is beneficial for Murray's to swap interest rates.

Murray's Can Borrow Money at a Fixed Rate of 10