Question

test. पq.S. N IOS EX: SWAPS Suppose a firm can borrow at Prime +3. lor at q fixed for 5 yrs. If a SWAP II available w/lo1 fixed for prime + 6X, then What is the best fixed rate option for the firm? Day: 8+3.) +101 Recieve: Atb.x. Metlist -3x+101 = 7 fixed it taice SWAP * Short Wt: SWAP=101-b1 - UN better off wi . Fixed=81-3.1=5NT SWAP

Please explain why how did they SWAP step by step and no handwriting thanks!!!

Answer 1

Let us consider the net rate at which the firm will pay interest on its borrowings in each alternative:

1. The company can either borrow at a fixed rate of 8%. In this case, this is the final rate at which it will pay interest for each period.

2. The company can borrow at Prime Rate + 3% and swap it for a fixed rate:

But the party which will swap is ready to pay Prime Rate + 6% every period if it receives 10% fixed rate for each period

So our firm will pay 10% fixed rate to the other party that will swap and will receive Prime Rate + 6% in return. Out of this, the firm will pay Prime Rate + 3% as its interest charge (each period)

Tus we can write net return as: -10% + P+6% -(P+3%) = -10% + 3% = -7% ( Minus sign implying outflow)

So the final interest cost for the firm, in this case, turns out to be 7% per period which is better than 8%. So the firm should proceed as per this scheme.

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