A firm can borrow at a fixed rate of 6.5% on long-term loans.If it swaps its long-term payments so that it receives 4% and pays a floating rate of LIBOR,what is the rate of interest on its borrowing?
A)LIBOR + 2.5%
B)LIBOR
C)LIBOR + 6.5%
D)LIBOR - 2.5%
E)LIBOR - 4%

Question

Quizplus · Accepted Answer

The firm initially borrows at a fixed rate of 6.5%. By entering into a swap where it pays LIBOR and receives 4%, the net effect is that it pays LIBOR, but effectively reduces its cost by the 4% it receives. Thus, the firm's total cost of borrowing becomes LIBOR + (6.5% - 4%) = LIBOR + 2.5%.

A Firm Can Borrow at a Fixed Rate of 6