10-22
DERIVATIVE SECURITIES
ANSWER KEY
5. In an interest rate swap transaction, the notional principal is:
c) never exchanged between the counterparties.
6. Consider the rates available in the market to Mega Corporation and Super, Inc.
Fixed Rate
Floating Rate
Mega Corporation
9.00%
LIBOR + 1.5%
Super, Inc.
11.25%
LIBOR + 2.25%
Currently, Mega Corporation is paying 9.00% to bondholders, but it wants
to replace this fixed rate financing with floating rate financing. Super, Inc.
pays LIBOR + 2.25% to investors in need of fixed rate financing. Super
agrees to pay Mega fixed rate payments of 9%; Mega agrees to pay Super
floating rate payments of LIBOR + 0.75%. How much would each company
save on the financing it needs by entering into a fixed / floating rate swap
transaction?
Mega 0.75%
a
Super 0.75%
a
Cash Flow
Mega Corporation
Super, Inc.
Payment to investors
- 9.00%
- LIBOR + 2.25%
Pays in swap
- LIBOR + 0.75%
- 9.00%
Receives in swap
+9.00%
+LIBOR + 0.75%
Net payment
- LIBOR + 0.75%
- 10.50%
Rate available in market
LIBOR + 1.50% Floating
11.25% Fixed
Net payment in swap
LIBOR + 0.75%
a
10.50%
a
Savings
0.75% Floating
0.75% Fixed
Both companies save 0.75% by entering into an interest rate swap to get the
type of funding they need.