Question

Currently, Company FMA has a 5-year floating-rate loan at £ Libor +1% (of £1 million principal),...

  1. Currently, Company FMA has a 5-year floating-rate loan at £ Libor +1% (of £1 million principal), and it is concerned about a possible appreciation in the value of the £ and an increase in interest rate. Current exchange rate, S = 1.8 $/£. (4pts)

Suppose that a swap dealer offers the following two swap quotes:

FMA pays dealer $ 6.50% for £ Libor%.

FMA pays dealer £ Libor% for $ 6.40%.

  1. What is the current borrowing cost for Company FMA?

  1. Which of the above two quotes is more appropriate for intended hedging purpose of Company FMA;   Quote A or B? Describe the exchange of cash flows that will take place with the swap.

  1. What is the with-swap borrowing cost for Company FMA?
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Answer #1

Answer A ) the current borrowing cost for FMA is simply Libor+ 1%

Answer B) Since FMA has taken loan with floating rate interest and is concerned about rising interest rates , he would be most benefited by entering into a swap transaction which leads him to pay a fixed rate of interest.

Hence swap quote A which is  FMA pays dealer $ 6.50% for £ Libor% will be most beneficial the cashflows will be

C) with swap borrowing cost is $6.5% + 1%

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