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 above

Question

Quizplus · Accepted Answer

The fixed rate payments of 6 percent are higher than the agreed borrowing rate of 5 percent. Therefore, the party receiving fixed rate payments will pay the other party the difference, which is 1 percent. However, the party receiving fixed rate payments also receives payments tied to LIBOR, which partially offset the fixed rate payments. The net result is that the party receiving fixed rate payments pays LIBOR - ½ percent to the other party. Therefore, the all-in-cost of the swap to the party receiving fixed rate payments is LIBOR - ½ percent.

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