Question

Firm ABC needs to borrow $1 million at a floating rate. In the market, firm ABC can borrow at 13% fixed rate per year or a floating rate equal to LIBOR. A swap bank proposes a swap contract. Firm ABC pays the swap bank a floating rate equal to LIBOR + 1% per year, and the swap bank pays firm ABC a fixed rate 15% per year. If firm ABC borrows $1 million at 13% fixed rate and gets into this swap contract, what is the value of this swap contract to firm ABC?

$ 0.3 million

• $0.05 million

• $ 0.23 million

• $ 0.1 million

Answer 1

Applicable floating rate = LIBOR

paid to swap bank = LIBOR + 1%

Applicable fixed rate = 13%

Received from Swap Bank = 15%

Net Benefit = 1%

Hence, value of swap contract = 1%*1 million

= $0.1 million