Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown below: A swap bank proposes the following interest only swap: Y will pay the swap bank annual payments on $10,000,000 with a fixed rate of rate of 9.90%.in exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR - 0.15%; What is the value of this swap to company Y?
A)Company Y will save 15 basis points per year on $10,000,000 = $15,000 per year.
B)Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year.
C)Company Y will save 5 basis points per year on $10,000,000 = $5,000 per year.
D)Company Y will only break even on the deal.

Question

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown below:  A swap bank proposes the following interest only swap: Y will pay the swap bank annual payments on $10,000,000 with a fixed rate of rate of 9.90%.in exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR - 0.15%; What is the value of this swap to company Y?
A)Company Y will save 15 basis points per year on $10,000,000 = $15,000 per year. 
B)Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year. 
C)Company Y will save 5 basis points per year on $10,000,000 = $5,000 per year. 
D)Company Y will only break even on the deal.

Quizplus · Accepted Answer

To calculate the value of the swap to company Y, we need to compare the fixed rate borrowing cost that company Y would face without the swap to the cost with the swap.

Without the swap, company Y would face a fixed borrowing cost of 10.50%, based on the table provided.

With the swap, company Y will pay a fixed rate of 9.90% to the swap bank, and will receive payments based on LIBOR - 0.15%. Using the forward rates provided in the table, we can estimate a 5-year average LIBOR rate of 9.30%, which would result in a net funding cost of 9.15% for company Y.

Thus, the swap provides a net savings of 35 basis points per year (10.50% - 9.15%), or $35,000 per year on the $10,000,000 notional amount. Therefore, the correct answer is B, Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year.

Company X Wants to Borrow $10,000,000 Floating for 5 Years;