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Q17I

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Essentials Of Investments
Found in: Page 590
Essentials Of Investments

Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

Short Answer

Desert Trading Company has issued $100 million worth of long-term bonds at a fixed rate of 7%. The firm then enters into an interest rate swap where it pays LIBOR and receives a fixed 6% on notional principal of $100 million. What is the firm’s overall cost of funds?

Answer

LIBOR + 1%

See the step by step solution

Step by Step Solution

Step 1: Given information:

Interest payable on bond = 7%.

Fixed interest rate receive in SWAP is 6%.

Interest rate pay in SWAP is LIBOR.

Step 2: Calculation of firm’s overall cost of funds

The company sold its 7% fixed rate loan for 6% in the SWAP, the effective interest rate on borrowing will be 1% above LIBOR.

Hence overall cost of funds is = LIBOR + 1%

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