Q. XYZ company has a floating rate borrowing , whose interest rate is LIBOR + 1.5%. The directors are concerned that the interest rates are going to rise so have approached a bank to discuss entering an interest rate swap. The bank has quoted a swap rate of 5% against Libor. What is the net interest XYZ will pay if it enters into the swap agreement?
The answer is 6.5% = (L+1.5%) + 5% – L
BUT my question is why is that? How are you getting the 6.5% based on above?
I know that this is a small area of the exam but I don’t seem to get this solution in terms of the numbers.
So the bank has quoted an offer rate of 5% fixed that the bank is prepared to receive in order to pay Libor so that company XYZ can pay a fixed rate instead. So how did it get to the 6.5%?