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Chapter 12

Solution

The answer is (B).

Actual borrowing (4.40%)
Payment to bank (LIBOR)
Receipt from bank 4.10%
––––––
Net (LIBOR + 0.30%)
–––––––––––––––

The interest fixing date is the start date of the year, so this overall net rate of
LIBOR + 0.30% can be calculated as 4.25% (LIBOR on the year 2 start date)
+ 0.30% = 4.55%.

Hence, Spray Co pays 4.55% interest on its $10 million borrowing ($455,000
in the year) rather than the 4.40% fixed rate it would have paid without the
swap ($440,000 in the year).

This is an extra cost of $15,000.

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