Heather $\backslash (\backslash$mathrm$\{$O$\}^\{\backslash$prime$\}\backslash )$ Reilly, the treasurer of CH Solations, helieves interest rates are going to rise, so she wants to swap her future floating rate interest payments for fixed rates. At present she is paying LIHOR $\backslash (-2\backslash \%\backslash )$ per annum on $\backslash (\backslash$$ $5,000,000\backslash )$ of debt for the next rao years, with payments due semiannally. LIBOR is currently $\backslash (4\mathrm{.}00\backslash \%\backslash )$ per annum. Ms$.$ OReilly has just made an interest payment today, so the bext payment is due six months from today.

Ms$.$ O'Keilly finds that she can swap ber current floating rate payments for fixed payments of $\backslash (7\mathrm{.}00\backslash \%\backslash )$ per annum. $($CB Solution's weighted average cost of capital is $\backslash (12\backslash \%\backslash ),$ which Ms $.$ O'Reilly calculates to be $\backslash (6\backslash \%\backslash )$ per six month period, compounded semiannually$).$

a$.$ If LIBOR rises at the rate of $50$ basis points per six month period, starting tomorrox, bow much does Ms$.$ OReilly save or cost her company by making this swap?

b$.$ If LIBOR falls at the rate of $25$ hasis points per six month period, starting tomormow, how much does Ms$.$ O'Reilly save or cost her company by making this swap?

Assumptions

Notional principal

LIBOR, per annum

Spread paid over LIBOR, per annum

Swap rate, to pay fixed, per annum

Interest $\backslash$& Swap Payments

a$.$ LIBOR increases $50$ basis pts$/6$ months Expected LIBOR

Current loan agreement:

Fxpected LIBOR $($for $6$ months$)$

Spread $($for $6$ months$)$

Expected interest payment

Swap Agreement:

Pay fixed $($for $6-$months$)$

Receive floating $($LIBOR for $6$ months$)$

Net interest $($loan $+$ swap$)$

Swap savings?

Net interest after swap

Loan agreement imterest

Swap savings $($swap cost$)$

b$.$ LBOR decreases $25$ basis pts$/6$ months

Current loan agreement:

Fxpected L$1$BOR $($for $6$ months$)$

Spread $($for $6$ months$)$

Expected interest payment

Swap Agreement:

Pay fixed $($for $6-$months$)$

Receive floating $($LIBOR for $6$ months$)$

Net interest $($loan $+$ swap$)$

Swap savings?

Net interest after swap

Loan agreement imerest

Swap savings $($swap cost$)$

In both cases CB Solutions is suffering higher total interest costs as a result of the swap.