AN OIL DRILLER RECENTLY ISSUED USD 250 MILLION OF FIXED-RATE DEBT...
21.
An oil driller recently issued USD 250 million of fixed-rate debt at 4.0% per annum to help fund a new project.
It now wants to convert this debt to a floating-rate obligation using a swap. A swap desk analyst for a large
investment bank that is a market maker in swaps has identified four firms interested in swapping their debt
from floating-rate to fixed-rate. The following table quotes available loan rates for the oil driller and each firm:
Firm
Fixed-rate (in %)
Floating-rate (in %)
Oil driller
4.0
6-month LIBOR + 1.5
Firm A
3.5
6-month LIBOR + 1.0
Firm B
6.0
6-month LIBOR + 3.0
Firm C
5.5
6-month LIBOR + 2.0
Firm D
4.5
6-month LIBOR + 2.5
A swap between the oil driller and which firm offers the greatest possible combined benefit?
a.
Firm A
b.
Firm B
c.
Firm C
d.
Firm D
Correct Answer: c
Rationale:
Since the oil driller is swapping out of a fixed-rate and into a floating-rate, the larger the difference
between the fixed spread and the floating spread the greater the combined benefit. See table below:
Firm
Fixed-rate
Floating-rate
Fixed-spread
Floating-spread
Possible Benefit
Oil driller
4.0
1.5
Firm A
3.5
1.0
-0.5
-0.5
-0.0
Firm B
6.0
3.0
2.0
1.5
0.5
Firm C
5.5
2.0
1.5
0.5
1.0
Firm D
4.5
2.5
0.5
1.0
-0.5
Section:
Financial Markets and Products
Reference:
John Hull,
Options, Futures and Other Derivatives, 9th Edition, Chapter 7, “Swaps.”
Learning Objective:
Describe the comparative advantage argument for the existence of interest rate swaps and
evaluate some of the criticisms of this argument.
2015 Financial Risk Manager (FRM®) Practice Exam