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Floating vs Fixed rate, Interest rate swap, Hedging

1. Two Lips, Limited, a Dutch bulb exporter, needs to borrow $40,000,000 for three years. They have the following alternatives: (a) Borrow for 3 years at 6.25% fixed rate. (b) Borrow at LIBOR + 1.75. LIBOR is currently 3.5% and will reset every six months over the life of the loan. (c) Borrow for one year at 4.75%. They would refinance the loan at the end of the year. What are the advantages and disadvantages of each alternative? What should they do? Why?

2 Itsa Corporation and Ovah, Limited both seek funding at the lowest possible cost. Itsa would prefer a floating-rate loan while Ovah wants the stability of fixed-rate borrowing. Itsa is more creditworthy. Itsa is AA rated, can borrow at 6% in the fixed rate market, and can borrow at LIBOR +2% in the floating rate market. Ovah is BB rated, can borrow at 10% in the fixed rate market, and can borrow at LIBOR + 3% in the floating rate market. What should they do?

3.Uncle Ben's uses imported rice from Japan. Payment of ¥12,000,000 is due in 3 months. The current spot rate is ¥123/$, the 3-month forward rate is ¥120/$, and the 6-month forward rate is ¥119/$. The annual Japanese interest rate is 0.75% while the annual U.S. interest rate is 2.00%. A 3-month call option with a ¥123 strike has a 3.5% premium while a 6-month call options with a ¥123 strike requires a 5.0% premium. The company's weighted average cost of capital is 11%. What are the costs of each alternative? What are the risks of each alternative? Which alternative should Uncle Ben's choose if it is willing to take a reasonable risk?

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Answers questions on Borrowing at Floating vs Fixed rate, Interest rate swap, Costs and risks of Hedging alternatives.