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FINC6013 Workshop 6 Questions

Chapter 21 problems

1. General Motors (GM) wants to swap out of $15,000,000 of fixed interest rate debt and into floating interest rate debt for 3 years. Suppose the fixed interest rate is 8.625% and the floating rate is dollar LIBOR. What semiannual interest payments will GM receive, and what will GM pay in return?

2. Pfizer is a U.S. firm with considerable euro assets. It is considering entering into a currency swap involving $10 million of its dollar debt for an equivalent amount of euro debt. Suppose the maturity of the swap is 8 years, and the interest rate on Pfizer’s outstanding 8-year dollar debt is 11%. The interest rate on the euro debt is 9%. The current spot exchange rate is $1.35/€. How could a swap be structured?

3.  At the 7-year maturity, the market sets the price of U.S. Treasury bonds to have a yield to maturity of 7.95% p.a. The Second Bank of Chicago states that it will make fixed interest rate payments on dollars at the yield on Treasury bonds plus 55 basis points in exchange for receiving dollar LIBOR, and it will receive fixed interest rate payments on dollars at the yield on Treasury bonds plus 60 basis points in exchange for paying dollar LIBOR. If you enter into an interest rate swap of $10 million with Second Chicago, what will be your cash flows if you are paying the fixed rate and receiving the floating rate?

4. The swap desk at UBS is quoting the following rates on 5-year swaps versus 6 month dollar LIBOR:

U.S. dollars: 8.75% bid and 8.85% offered

Swiss francs: 5.25% bid and 5.35% offered

You would like to swap out of Swiss franc debt with a principal of CHF25,000,000 and into fixed-rate dollar debt. At what rates will UBS handle the transaction? If the current exchange rate is CHF1.3/$, what would the cash flows be?

8. Assume that 4 years have passed since you entered into the transaction described in problem 4. Assume that the new spot exchange rate is CHF1.45/$ and that UBS is now quoting the following interest rates on 1-year swaps:

U.S. dollars: 7.50% bid and 7.60% offered against the 6-month dollar LIBOR

Swiss francs: 6.75% bid and 6.85% offered against the 6-month dollar LIBOR

If you close out the swap transaction of problem 4, what net dollar cash flow will you experience? Explain why this is the correct amount. You can assume that the term structures of interest rates in both currencies are flat.