• Company A is a financing company. • Company A has 30% debt in its capital structure, out of which 55% is floating-rate debt indexed to the LIBOR (London interbank offered rate). • Company A financed company C and earns a fixed interest of 8% per annum. • Company B is a bank. • Company B gives its depositors an average of 6% fixed return on the 10 million certificates of deposit in the bank. The bank lends money to corporations at floating rates indexed to the LIBOR.
• Company A is a financing company. • Company A has 30% debt in its capital structure, out of which 55% is floating-rate debt indexed to the LIBOR (London interbank offered rate). • Company A financed company C and earns a fixed interest of 8% per annum. • Company B is a bank. • Company B gives its depositors an average of 6% fixed return on the 10 million certificates of deposit in the bank. The bank lends money to corporations at floating rates indexed to the LIBOR.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
All option are Company B, Company A
Transcribed Image Text:Company A
• Company A is a financing company.
• Company A has 30% debt in its capital structure,
out of which 55% is floating-rate debt indexed to
the LIBOR (London interbank offered rate).
• Company A financed company C and earns a fixed
interest of 8% per annum.
Company B
• Company B is a bank.
• Company B gives its depositors an average of 6%
fixed return on the 10 million certificates of
deposit in the bank.
The bank lends money to corporations at floating
rates indexed to the LIBOR.
The financing company agrees to pay fixed-rate obligations to the bank, and the bank pays the financing company a
floating-rate payment based on LIBOR.
Company A and Company B enter into an interest rate swap agreement with each other for three years. Six months
into the contract, LIBOR decreases by 0.50%.
Which of the two companies will benefit from the protection that the swap provides?
Company B
Company A
This is because
earns floating interest that is indexed to the LIBOR but has to pay fixed interest on
its debt. So if LIBOR decreases, the company earns less but will have to pay the same interest on its debt. Because
the companies got into an interest rate swap in which
would pay the other company a fixed interest
rate, a decrease in LIBOR would mean more interest earnings from the swap in the form of fixed interest that
balances the decreased earnings from the floating interest rate.
Another kind of swap is a credit default swap. A credit default swap (CDS) is a contract that transfers credit risk from
one counterparty (protection buyer) to another counterparty (protection seller).
Which party pays fees to the other party so that the insurer makes the payment toward the debt to the lender when
the borrower defaults?
Transcribed Image Text:Which party pays fees to the other party so that the insurer makes the payment toward the debt to the lender when
the borrower defaults?
O Protection seller
O Protection buyer
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