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balu736 [363]
3 years ago
15

"Lluvia Manufacturing and Paraguas Products both seek funding at the lowest possible cost. Lluvia would prefer the flexibility o

f floating rate borrowing, while Paraguas wants the security of fixed rate borrowing. Lluvia is the more credit-worthy company. With the better credit rating, Lluvia has lower borrowing costs in both types of borrowing. Assumptions   Lluvia   Paraguas Credit rating   AAA   BBB Prefers to borrow   Floating   Fixed Fixed-rate cost of borrowing   6.000%   12.000% Floating-rate cost of borrowing:         LIBOR (current=4%)   4.000%   4.000% Spread   1.000%   4.000% Total floating-rate   5.000%  
8.000%"However, it could borrow at LIBOR + 2.000% and swap for fixed rate debt. What should they do? (LIBOR is 5.500%)
Business
1 answer:
JulijaS [17]3 years ago
7 0

Answer:

Paraguas should borrow at LIBOR + 2.000% and swap for fixed rate debt.

Lluvia should choose funding in floating rate

Explanation:

Paraguas wants the security of fixed rate borrowing; thus it should borrow at LIBOR + 2.000% and swap for fixed rate debt, in which Libor is 5.500%; their total cost at 7.5% is still lower than Fixed rate 12.0%

Lluvia prefer the flexibility of floating rate borrowing, and its rating is better; then it can enjoy lower cost of borrowing at 5%. However it may face the increase if LIBOR increase later; vice versa if LIBOR decrease, its cost of borrowing is able to reduce also.

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To find the price of the bond, can either use excel or with formula.

When input the below formula in excel,

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Coupon Amount (PMT): $25 (Semi annual coupon amounts)

Number of years (NPER) = 26

YTM (rate) = 10%/2 = 5%

Face Value: $1000

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To find the price of the bond, can either use excel or with formula.

When input the below formula in excel,

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P1 =pv(5%,26,-25,-1000)

When input the formula in excel, we get PV as $640.62

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%change = (P1 – P0)/P0

%change = ($640.62 - $760.26)/$760.26

%change = -18.68%

Therefore, with the increase in 2% YTM of BOND J, the price falls by 18.68%

Bond K :

(WHEN YTM IS 8%)

Coupon Rate: 11%

Coupon Amount (PMT): $1,000 * 11% = $110/2 = $55 (Semi annual coupon amounts)

Number of years (NPER) = 13*2 = 26

YTM (rate) = 8%/2 = 4%

Face Value: $1000

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To find the price of the bond, can either use excel or with formula.

When input the below formula in excel,

PV =pv(rate,nper,pmt,fv,type)

P0 =pv(4%,26,-55,-1000)

When input the formula in excel, we get PV as $1,239.74

(WHEN YTM RISES BY 2%, NEW YTM IS 10%)

Coupon Amount (PMT): $55 (Semi annual coupon amounts)

Number of years (NPER) = 26

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When input the below formula in excel,

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Therefore, with the increase in 2% YTM of BOND k, the price falls by 13.54%

SIMILALRY IF THE BOND PRICES FALLS BY 2%, the YTM WILL BE 6%/2 = 3% **(REFER THE IMAGE ATTACHED)

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