Question

Carter Enterprises can issue floating-rate debt at LIBOR + 3% or fixed-rate debt at 9%. Brence Manufacturing can issue floating-rate debt at LIBOR + 2.5% or fixed-rate debt at 12%. Suppose Carter issues floating-rate debt and Brence issues fixed-rate debt. They are considering a swap in which Carter makes a fixed-rate payment of 7.60% to Brence and Brence makes a payment of LIBOR to Carter. What are the net payments of Carter and Brence if they engage in the swap? Round your answers to two decimal places. Use a minus sign to enter negative values, if any.

Net payment of Carter:   %

Net payment of Brence: -(LIBOR +   %)

Would Carter be better off if it issued fixed-rate debt or if it issued floating-rate debt and engaged in the swap?

The swap is good for Carter, if it issued -Select-fixed-rate debtfloating-rate debt and engaged in the swapItem 3 .

Would Brence be better off if it issued floating-rate debt or if it issued fixed-rate debt and engaged in the swap?

The swap is good for Brence, if it issued -Select-floating-rate debtfixed-rate debt and engaged in the swapItem 4 .

Answer 1

Solution:

a) Net Payment of Carter:

• Carter paying to bank = Libor + 3%
• Carter paying to Brence = 7.6%
• Carter receiving from Brence = Libor

Net Payment = Libor + 3% + 7.6% - Libor = 10.6%

b) Net Payment of Brence:

• Brence paying to bank = 12%
• Brence paying to Carter = Libor
• Brence receiving from Carter = 7.6%

Net Payment = 12% + Libor - 7.6% = Libor + 4.4%

c) Would Carter be better off if it issued fixed-rate debt or if it issued floating-rate debt and engaged in the swap?Answer = "fixed-rate debt" ; Reason - As it would have to pay only 9% instead of 10.6% in case of no swap.

d) Would Brence be better off if it issued floating-rate debt or if it issued fixed-rate debt and engaged in the swap?Answer = "floating-rate debt" ; Reason - As it would have to pay only (Libor + 2.5%) instead of (Libor + 4.4%) in case of no swap.