Question

Marx and Winter, Inc. operate a chain of retail clothing stores throughout the U.S. Midwest. The firm recently entered into a loan agreement for $20 million that carries a floating rate of interest equal to LIBOR plus 50 basis points (1/2 percent). The loan has a five-year maturity and requires the firm to make semiannual payments. At the time the loan was being negotiated, Marx and winter was approached by its banker with a suggestion as to how the firm might lock in the rate of interest on the loan at 6.4 percent using a fixed-for-floating interest rate swap. Under the agreement the company would make a cash payment to the swap counterparty equal to the fixed-rate coupon payment and receive in return a coupon payment reflecting the floating rate.
a. Calculate the swap cash flows over the next five years based on the following set of hypothetical LIBOR rates:
Year (A) Six-Month LIBOR Rate (B)
0.00 ............ 5.44%
0.50 ............ 7.20%
1.00 ............ 6.40%
1.50 ............ 5.92%
2.00 ............ 6.24%
2.50 ............ 6.88%
3.00 ............ 7.20%
3.50 ............ 7.36%
4.00 ............ 6.72%
4.50 ............ 6.08%
5.00
b. What would motivate a firm’s management to enter into a swap contract?



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  • CreatedOctober 31, 2014
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