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Buyer Limited design to sign an interest rate swap agreement to pay a floating rate and receive a fixed rate. The swap contract can help Buyer Limited to convert $100 million, 4.6% fixed interest rate bond into a floating rate payment. The floating rate is indexed to the six-month LIBOR minus 0.52%.

(a) Explain why Buyer Limited use a swap agreement rather than issue a floating-rate bond?

(b)Determine the net cash flow to Buyer Limiter when the LIBOR is 5% at the interest payment settlement date.

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Irving Heathcote
Irving HeathcoteLv2
28 Sep 2019
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Use the following information to answer questions 5-6.
A construction company goes to a regional bank to secure a $25 million loan to finance
expansion. The bank agrees to make the quarterly loan, with a loan interest rate equal to
3-month LIBOR + 300 basis points. The company then contacts a swaps dealer and
enters into an interest rate swap, agreeing to pay a fixed rate of 4.0% in exchange for
receiving a floating rate of 3-month LIBOR + 300 bps. The notional principal of the swap
is $25 million, and the quarterly swap’s interest payment dates are aligned with the loan’s
interest payment dates. All swap payments are made quarterly and on the basis of 30
days per month and 360 days per year. At inception, 3-month LIBOR is 0.75%.

• Three months after swap inception, on the first quarterly settlement date, 3-month
LIBOR is 1.20%.
• Six months after swap inception, on the second quarterly settlement date, 3-month
LIBOR was 0.90%.


5. Which of the following will most likely take place on the first swap settlement date?
To settle the swap (to the nearest dollar), the construction company: (3 points)
a) pays the dealer $12,500.
b) pays the dealer $15,625.
c) receives $12,500 from the dealer.
d) receives $15,625 from the dealer.

6. Which of the following will most likely take place on the second swap settlement
date? To settle the swap (to the nearest dollar), the construction company: (3 points)
a) pays the dealer $6,250.
b) pays the dealer $12,500.
c) receives $6,250 from the dealer.
d) receives $12,500 from the dealer.

2. Decision to Hedge with Interest Rate Swaps

Explain the types of cash flow characteristics that would cause a firm to hedge interest rate risk by

swapping floating-rate payments for fixed payments. Why would some firms avoid the use of interest rate swaps even when they are highly exposed to interest rate risk?

7. Fixed-for-Floating Swaps North Pier Company entered into a two-year swap agreement, which would provide fixed-rate payments for floating-rate payments. Over the next two years, interest rates declined. Based on these conditions, did North Pier Company benefit from the swap?

8. Equity Swap Explain how an equity swap could allow Marathon Insurance Company to capitalize on expectations of a strong stock market performance over the next year without altering its existing portfolio mix of stocks and bonds.

13. Use of Interest Rate Swaps Explain why some companies that issue bonds engage in interest rate swaps in financial markets. Why do they not simply issue bonds that require the type of payments (fixed or variable) that they prefer to make?

15. Rate-Capped Swaps Bull and Finch Company wants a fixed-for-floating swap. It expects interest rates to rise far above the fixed rate that it would pay and to remain very high until the swap maturity date. Should it consider negotiating for a rate-capped swap with the cap set at 2 percentage points above the fixed rate? Explain.

16. Forward Swaps Rider Company negotiates a forward swap, to begin two years from now, in which it will swap fixed payments for floating-rate payments. What will be the effect on Rider if interest rates

rise substantially over the next two years? That is, would Rider be better off using this forward swap than if it had simply waited two years before negotiating the swap? Explain.

19. Credit Default Swaps Credit default swaps were once viewed as a great innovation for making mortgage markets more stable. Recently, however, the swaps have been criticized for making the credit crisis worse. Why?

Question 1 Company A offers $30 per share to acquire Company B. Company's B estimated value of equity is $50 million, it has debt of 5 million, and outstanding shares of 2 million. This will probably result in: no change in Company B's stock price a decrease in Company B's stock price an increase in Company A's stock price Correct! a decrease in Company A's stock price none of the above Question 2 In a financial merger: the merged companies combine operations Equity is used to finance the merger Debt is used to finance the merger Correct! the merged companies do not combine operations none of the above Question 3 Delta Airlines and Northwest Airlines merged in 2008. This merger is an example of: a vertical merger Correct! a horizontal merger a conglomerate merger more information is needed to answer this question none of the above Question 4 Delta airlines acquired an oil refinery in Pennsylvania in 2012. This is an example of: a vertical merger a horizontal merger You Answered a conglomerate merger more information is needed to answer this question none of the above Question 5 Company A is interested in acquiring Company B. Estimated present value of Company B is $1 billion. Company B has 50 million shares of stock outstanding and no debt. Company B's book value is $22.50. Without considering possible synergies, what is the maximum price per share that Company A should offer? $16.25 $22.50 $20.00 $25.25 You Answered none of the above Question 6 The December Treasury bond futures contract has a quoted price of 95'18. If annual interest rates go up by 1.00 percentage point, what is the value of one contract? $85,538.15 $85,622.89 $88,845.41 85,211.70 You Answered none of the above Question 7 Two companies are evaluating a possible swap. Company A can issue floating-rate debt at LIBOR + 1%, and it can issue fixed rate debt at 9%. Company B can issue floating-rate debt at LIBOR + 1.5%, and it can issue fixed-rate debt at 9.4%. If A issues floating-rate debt and B issues fixed-rate debt, and then they engage in the following swap: A will make a fixed 7.95% payment to B, and B will make a floating-rate payment equal to LIBOR to A. Which of the following statements is correct? The swap is advantageous to A, but not to B You Answered The swap is advantageous to B, but not to A The swap is advantageous to both A and B The swap is not advantageous to either A or B none of the above Question 8 "The June Treasury bond futures contract has a quoted price of 102'12. Are current market interest rates higher or lower than the standardized rate on a futures contract? higher, because the contract is selling at a discount higher, because the contract is selling at a premium Correct! lower, because the contract is selling at a premium more information is required to answer this question None of the above answers is correct Question 9 The June Treasury bond futures contract has a quoted price of 102'12. What is the current value of one contract in dollars? 90,180 90,563 You Answered 102,120 102,375 none of the above Question 10 The June Treasury bond futures contract has a quoted price of 102'12. What is the implied annual interest rate? 5.80% You Answered 2.90% 5.85% 3.05% none of the above

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