1. Suppose you issue 5-yr Floating rate financing at LIBOR 30BP. You approach a swap dealer about swapping it into fixed. The dealer is offering Dealer-pays-fixed at 4% and Dealer-receives-fixed at 4.08% (both in exchange for LIBOR flat). Consider swapping your floating rate financing into fixed and then swapping it back synthetically (using caps and/or floors). Here are the quotes from a dealer on Caps and Floors:

Strike Rate Dealer buys a 5-year cap Dealer sells a 5-year cap

4% 115 BP 120 BP

5% 72 BP 77 BP

6% 32 BP 35 BP

Dealer buys a 5-year floor Dealer sells a 5-year floor

4% 88 BP 93 BP

5% 440 BP 448 BP

6% 784 BP 795 BP

1. Take your original floating rate loan and swap it into fixed rate financing then synthetically swap it back into floating using caps and floors (use a notional amount of $500 million). Use the 5% Cap & Floor. What is your eventual cost of financing arranged in this manner?
2. Now suppose your original loan was to issue fixed at 4.5%. You go swap dealer to swap it into floating and then synthetically swap it back using caps & floors. What is you eventual cost of financing when engineered in this way (use the 5% cap and the 5% floor)?
3. Re-compute your synthetically engineered fixed rate (as in (b)) using the 6% cap and the 6% floor.How does this compare with your answer in (b)?

• Note: use 5% for amortization

Answer rating: 100% (QA)

To determine the eventual cost of financing in each scenario we need to calculate the cash flows for ... View the full answer