Please show work thanks Sunrise Finance Inc. can borrow at a fixed rate of 10% o
ID: 2793083 • Letter: P
Question
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Sunrise Finance Inc. can borrow at a fixed rate of 10% or at LIBOR-0596. Kingdom Manufacturing can borrow at a fixed rate of 13% or at LIBOR+1%. a. Suppose Sunrise Finance prefers a floating rate loan while Kingdom Manufacturing prefers a fixed rate loan. Is there a mutually advantageous opportunity to engage in an interest rate swap? Briefly explain. (2 points) Kingdom Manufacturing proposes to pay 10.5% in return for LIBOR-0.7%. What is the cost of borrowing for Sunrise and Kingdom after the swap? (7 points) c What is the cost saving that each party realizes under the swap terms in part b.? (3 points)Explanation / Answer
a) Two parties will enter a swap only if their is a mutual benefit over the current rates available. Sunrise wants a floating rate and Kingdom wants a fixed rate. Now, if they enter a swap, they will borrow opposite to what they want and will swap the interest payments.
After the swap, Sunrise will make a payment of Libor + 1% but will get 2.25% (1.5% compensation + 0.75% gain) from Kingdom. So, the effective cost would be Libor - 1.25% (Libor + 1% - 2.25%) which is less than the current available Libor - 0.5%. Whereas Kingdom will make a payment of 10% + 2.25%, making a effective borrowing rate 12.25% over the currently available 13%.
b)
11.65%
c) Cost saving is the gain shared by the parties which 1.35% for each party.
Interest rate swap Particulars Sunirise Finance Inc Kingdom Manufacturing Fixed Rate Available 10% 13% Floating Rate Available Libor - 0.5% Libor + 1% Desired Borrowings (1) Libor - 0.5% 13% Actual borrowings 10% Libor + 1% After Swap Libor + 1% 10% Gain or (Loss) after Swap (-)1.5% 3% Compensated by A to B 1.5% (-)1.5% Total Gain 0% 1.5% Gain shared equally (2) 0.75% 0.75% Effective Borrowing Rate (1 - 2) Libor - 1.25% 12.25%