Traditionally firms raise capital in the primary market issuing either fixed or floating rate debt. Both bond
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One of your firm's clients wants to issue a $100 million, 3-year maturity bond and has asked for guidance as to achieving the lowest fixed rate borrowing cost. Based on current bond market
conditions the firms can:
• Issue a 3-year, fixed rate bond (annual coupon payments) paying the 3-year US Treasury rate plus 250 basis points. The current 3-year US Treasury rate is 4.50%.
• Issue a 3-year floating rate bond paying (annually) the 1-year SOFR rate plus 200 basis points.
The client's CFO asks whether they could lower their all-in fixed rate borrowing costs using an
interest rate swap.
As the junior derivatives analyst, you have been tasked with evaluating this situation and determining if the use of an interest swap would achieve the firm's goal. To that end you have
identified a bank that offers the following interest rate swap:
• Fixed Rate Leg: 3-year US Treasury rate plus 30 basis points.
• Floating Rate Leg: 1-year SOFR
You are to prepare a presentation for the client's CFO illustrating the financial structure that provides the lowest fixed rate borrowing cost as well the savings, if any, as a result of using an interest rate swap.