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Understanding the Savings using a Standby Letter of Credit (SLC)

A corporation is planning to issue $1,000,000 of 270-day commercial paper for an effective yield of 5%. The corporation expects to save 30 basis points on the interest rate by using either an SLC or a loan commitment as collateral for the issue:

What are the net savings to the corporation if a bank agrees to provide a 270-day SLC for an up-front fee of 20 basis points to back the commercial paper issue?

Please explain the concepts.

Solution Preview

Companies often issue CP's to finance their short term requirements. These are generally for less than a year.

In this problem, company is in need of $1,000,000 and might be expecting some cash flow (which is substantially more than a million dollars) in 270 days time.

Now, people at large are not sure whether the company would pay or default, so they ...

Solution Summary

The solution provides an excellent understanding of the concepts of using an SLC and the fees charged for the risk involved.

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