Question: The Baker Co. can borrow money at either a fixed rate of 7 percent or a variable rate set at prime plus 0.25 percent. The

The Baker Co. can borrow money at either a fixed rate of 7 percent or a variable rate set at prime plus 0.25 percent. The Costco Co. can borrow money at either a variable rate of prime plus 1 percent or a fixed rate of 7.5 percent. Suppose Costco issues fixed rate debt and Baker issues floating rate debt. The two companies enter into a swap agreement whereby Baker pays 6.75 percent to Costco and Costco pays prime plus 0.125 percent to Baker. Given this information, which one of the following statements is correct?

a. Costco ends up paying a fixed rate of 7.25 percent.

b. Costco ends up paying no more than the prime rate.

c. Both firms end up paying 0.125 less than otherwise possible.

d. Baker Co. ends up paying no less than 7 percent and no more than 7.5 percent as a fixed rate.

e. The companies are worse off as a result of the swap.

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