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sembilan co jun12

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › sembilan co jun12

  • This topic has 1 reply, 2 voices, and was last updated 4 months ago by John Moffat.
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  • February 20, 2022 at 3:54 am #648924
    Frooti
    • Topics: 52
    • Replies: 56
    • ☆☆

    Sembilan Co, a listed company, recently issued debt finance to acquire assets in order to
    increase its activity levels. This debt finance is in the form of a floating rate bond, with a
    face value of $320 million, redeemable in four years. The bond interest, payable annually, is
    based on the spot yield curve plus 60 basis points. The next annual payment is due at the
    end of year one.
    Sembilan Co is concerned that the expected rise in interest rates over the coming few years
    would make it increasingly difficult to pay the interest due. It is therefore proposing to
    either swap the floating rate interest payment to a fixed rate payment, or to raise new
    equity capital and use that to pay off the floating rate bond. The new equity capital would
    either be issued as rights to the existing shareholders or as shares to new shareholders.
    Ratus Bank has offered Sembilan Co an interest rate swap, whereby Sembilan Co would pay
    Ratus Bank interest based on an equivalent fixed annual rate of 3.76¼% in exchange for
    receiving a variable amount based on the current yield curve rate. Payments and receipts
    will be made at the end of each year, for the next four years. Ratus Bank will charge an
    annual fee of 20 basis points if the swap is agreed.
    The current annual spot yield curve rates are as follows:
    Year One Two Three Four
    Rate 2.5% 3.1% 3.5% 3.8%
    The current annual forward rates for years two, three and four are as follows:
    Year Two Three Four
    Rate 3.7% 4.3% 4.7%
    Required:
    (a) Explain
    why the fixed annual rate of interest of 3.76¼% is less than the four?year yield
    curve rate of 3.8%.

    Please tell this explanation as I didn’t get it from kaplan exam kit.

    February 20, 2022 at 9:50 am #648962
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 49603
    • ☆☆☆☆☆

    With the variable rate, some years that interest is lower and some years it is higher.

    The fixed rate is 3.7625% is therefore somewhere between the various variable rates.

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