Forums › ACCA Forums › ACCA AFM Advanced Financial Management Forums › Credit risk spreads and interest rate swaps
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- AuthorPosts
- May 30, 2010 at 1:42 pm #44272
One more question from me 🙂
Q2 from June 2009 exam paper. The company has debt $770 million at LIBOR + 70 basis points repayable at six years. Interest liability is swapped at fixed rate 5.5% in exchange for LIBOR (LIBOR is also 5.5%). The gearing will decrease under proposed option to reorganize, that will lead to decrease in spread by 30 basis points.The examiner states in his answer that ‘reduction in gearing would lead to a 30 basis points saving in interest on the variable component of the swap’, and then ‘Because the fixed rate and the floating rate are the same at 6·2% (given the current
credit spread is 70 basis points over LIBOR, or in addition to the swap rate of 5·5%) the nominal value of the company’s
debt is equal to its current market value’.I’m totally confused! How? I thought that it should have been vice versa: Market value of debt should increase, due to decrease in credit risk, while the company has no benefit from that because interest rate swap only locks in the LIBOR rate.
Please, explain to me that. - AuthorPosts
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