Evaluate Strategies to Hedge Against Rising Interest Rates Suppose Apple Computer has $100 million of two-year floating rate debt outstanding at LIBOR + 80 bp. In a swap, Apple can get LIBOR + 80 bp from intermediary in return for fixed payments to intermediary at 4 percent. Alternatively, Apple could purchase a 4 percent interest rate cap for the two years remaining until the debt matures. LIBOR is currently 3 percent.
Required
a. Assume LIBOR remains at 3 percent for the next two years. Compute the maximum amount Apple would pay for the cap and be indifferent between the swap and the cap. Ignore discounting.
b. Assume LIBOR does not remain at 3 percent for the next two years, and could go up or down. Explain the factors you would evaluate in deciding whether to make the swap or purchase the cap.
c. Suppose Apple also could transact in $100 million notional amount of interest rate futures at 96; the discount yield on the futures closely tracks movements in LIBOR. If Apple decides on the futures, should they be bought or sold? What other factors would you consider?