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CMA Final · Strategic Financial Management · Interest Rate Derivatives

Kaveri Textiles has a floating-rate loan costing MIBOR + 1.00% p.a. It enters a plain-vanilla swap in which it pays a fixed 7.50% p.a. and receives MIBOR from the swap dealer on the same notional and dates. What is its effective annual borrowing cost after the swap?

The effective cost is a fixed 8.50%. The MIBOR received under the swap cancels the MIBOR on the loan, so what remains is the 1% loan spread plus the 7.50% fixed rate paid on the swap.

  1. A8.50% fixedCorrect
  2. B6.50% fixed
  3. C7.50% fixed
  4. DMIBOR + 8.50% floating

Explanation

Net cost = (MIBOR + 1.00%) + 7.50% - MIBOR = 8.50%. The MIBOR received from the dealer offsets the MIBOR paid on the loan, leaving the spread plus the fixed rate. 6.50% subtracts the spread wrongly, and 7.50% forgets the 1% loan spread.

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