10 Swaps questions January 2018
Scarecrow: The sum of the square roots of any two sides of an isosceles triangle is equal to the square root of the remaining side. … I got a brain!
1. JC Penney encourages customers to use a JCP-brand credit card to buy clothes. The interest rate they charge on balances outstanding is LIBOR + 5.0%. LIBOR is currently 1.0%. Are their accounts receivable fixed rate or floating rate?
2. JC Penney borrows money via bank loans at LIBOR + 2.0%. Would this be a fixed or floating rate liability?
3. They also can offer bonds to the market for a ten-year term at 3.0% - would this be a fixed or floating rate liability?
…You are on the finance desk at JCP and the boss asks you if its better to borrow at LIBOR+ 2.0% or at a fixed rate of 3.0%...
4. The 10-year fixed-to-floating swap rate is 100 bp, that is,
The fixed rate payor pays the government rate of 2.5%, and…
The floating rate payor pays LIBOR +1.0%.
So, with LIBOR = 1.0%, the payment date would see the fixed rate payor paying 2.5% and the floating rate pays 1.0% plus 100bps, or 2.0%. Netting these two calculations we see that the fixed rate payor pays .5% and the floating rate payor actually receives .5%. T F
(more on following page…)
5. If JC Penney offers ten-year bonds at 3.0% yield, then swaps into floating rates, what floating rate will they be paying? (…swap price is LIBOR + 1.0%).
6. Is this higher or lower than their bank loan rate?
7. Is JC Penney treated more favorably in the long-term, fixed-rate debt market or the short-term, floating rate loan market?
8. If you are a speculator and think rates will rise, would you prefer to pay the fixed rate of 2.5% or the floating rate of LIBOR + 1.0%?
9. If enough speculators think rates will rise, will the swap rate rise to LIBOR + 2.0% or fall to LIBOR flat?
10. If the swap rate falls to LIBOR flat, what floating rate would JC Penney pay when they sell bonds at a 3.0% yield and swap into a floating rate?