Victor Brothers LLC should choose deal a) if it believes interest rates will remain below 2.9%, and deal b) if it believes interest rates will exceed 2.9%.
In this scenario, Victor Brothers LLC has borrowed $100 million at an annual interest rate of 3% for the next 5 years. The company believes that interest rates will be less than 2.9% during this period. Stuart and Partners propose two swap deals to Victor Brothers LLC. Deal a) involves Victor Brothers LLC paying 3% to Stuart & Partners and receiving LIBOR+0.1% in return for the next 5 years. Deal b) involves Victor Brothers LLC receiving 3% from Stuart & Partners and paying LIBOR+0.1% to Stuart & Partners for the next 5 years.
To determine which deal Victor Brothers LLC should choose, let's analyze each option. Deal a) means Victor Brothers LLC pays a fixed rate of 3% and receives a variable rate linked to LIBOR+0.1%. This deal will be beneficial for Victor Brothers LLC if LIBOR remains lower than 2.9%. If interest rates stay above 2.9%, Victor Brothers LLC will be paying more than it would with its existing loan. On the other hand, deal b) means Victor Brothers LLC receives a fixed rate of 3% and pays a variable rate linked to LIBOR+0.1%. This deal will benefit Victor Brothers LLC if LIBOR exceeds 2.9% because it will receive a higher interest rate compared to its existing loan.
Therefore, if Victor Brothers LLC believes that interest rates will be low and remain below 2.9% for the next 5 years, it should choose deal a) as it would pay a fixed 3% rate and receive a lower variable rate linked to LIBOR+0.1%. However, if Victor Brothers LLC believes that interest rates will rise and go above 2.9%, it should choose deal b) as it would receive a fixed 3% rate and pay a higher variable rate linked to LIBOR+0.1%.