Chapter 17, Problem 17PS

Summary Introduction

Character in this case:

Desert Trading Company.

Adequate information:

Total long-term bonds issued = $100 million

Fixed rate of interest of the issue = 7%

Firm has entered into interest swap where it pays LIBOR

Also it receives fixed rate of 6%

To construct:

Effective interest rate on borrowing.

Introduction:

An interest rate swap is a forward contract in which one stream of future interest payments is exchanged for another based on a specified principal amount. Interest rate swaps usually involve the exchange of a fixed interest rate for a floating rate, or vice versa, to reduce or increase exposure to fluctuations in interest rates or to obtain a marginally lower interest rate than would have been possible without the swap.