Find the all-in-cost of a swap to a party that has agreed to borrow $5 million at 5 percent externally and pays LIBOR + ½ percent on a notational principal of $5 million in exchange for fixed rate payments of 6 percent.
A)LIBOR + ½ percent
B)LIBOR
C)LIBOR − ½ percent
D)none of the options

Question

Quizplus · Accepted Answer

The all-in-cost of the swap can be calculated by comparing the fixed rate payment of 6 percent to what the party would have paid if they had borrowed at a floating rate. The floating rate is the external borrowing rate of 5 percent plus the LIBOR spread of 0.5 percent, giving a total of 5.5 percent. 
Therefore, the party will save 0.5 percent by entering into the swap. The fixed rate of 6 percent is inclusive of this savings, so the all-in-cost is actually 5.5 percent. Thus, the party will pay LIBOR - 0.5 percent on the notational principal of $5 million. Therefore, the correct answer is C.

Find the All-In-Cost of a Swap to a Party That