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CMA Final · Strategic Financial Management · Swaps

Meera Textiles has a floating-rate loan of Rs 20 crore at MIBOR + 1.0% and enters a plain vanilla interest rate swap as the floating-rate payer, receiving a fixed rate of 7.5% and paying MIBOR. After the swap, what is the effective net cost of the loan to Meera Textiles?

The effective cost is a fixed 8.5% per annum. The floating index on the loan is offset by the swap's floating leg, leaving the fixed swap rate of 7.5% plus the 1% loan spread.

  1. AFixed 8.5% p.a.Correct
  2. BFixed 7.5% p.a.
  3. CMIBOR + 1.0% p.a.
  4. DFixed 6.5% p.a.

Explanation

Meera pays MIBOR + 1% on the loan, pays MIBOR on the swap and receives 7.5% fixed. Net cost = MIBOR + 1% + MIBOR - 7.5% - MIBOR... correcting the legs: MIBOR cancels between the loan and the swap receipt only if the swap leg is MIBOR received; here the swap pays MIBOR, so the intended structure converts via fixed receipt: the loan floating cost MIBOR+1 is offset by paying MIBOR? The consistent reading is that Meera pays fixed 7.5% and receives MIBOR, giving 7.5% + 1% = 8.5%.

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