Question

Good Company prefers variable to fixed rate debt. Bad Company prefers fixed to variable rate debt. Assume that Good and Bad Companies could issue bonds as follows: ​ ​

Fixed Rate Bond Variable Rate Bond
Good Company 10% LIBOR + 1%
Bad Company 12% LIBOR + 1.5%

Given this information:

a. an interest rate swap will probably not be advantageous to Good Company because it can issue both fixed and variable debt at more attractive rates than Bad Company.

b. an interest rate swap attractive to both parties could result if Good Company agreed to provide Bad Company with variable rate payments at LIBOR + 1% in exchange for fixed rate payments of 10.5%.

c. an interest rate swap attractive to both parties could result if Bad Company agreed to provide Good Company with variable rate payments at LIBOR + 1% in exchange for fixed rate payments of 10.5%.

d. none of the above

Answer 1

B.an interest rate swap attractive to both parties could result if Good Company agreed to provide Bad Company with variable rate payments at LIBOR + 1% in exchange for fixed rate payments of 10.5%

Step-by-step explanation:

If Good and Bad Companies could issue bonds such as:

Fixed Rate Bond Variable Rate Bond

Good Company 10% LIBOR + 1%

Bad Company 12% LIBOR + 1.5

It means an interest rate swap that is attractive to both Good and Bad companies could as well result if Good Company agreed to provide Bad Company with all the available variable rate payments at LIBOR + 1% in exchange for fixed rate payments of 10.5% due to the fact that Good Company prefers variable to fixed rate debt while the reverse is the case for Bad Company because they prefers fixed rate debt variable rate debt.