Your firm needs to raise $ 100.00 million in funds. You can borrow short term at a spread of 1.0 % over LIBOR. Alternatively, you can issue 10 -year,…

Your firm needs to raise $ 100.00 million in funds. You can borrow short term at a spread of

1.0 % over LIBOR.​ Alternatively, you can issue 10​-year, ​fixed-rate bonds at a spread of 2.50% over 10​-year

​Treasuries, which currently yield 7.60%. Current 10​-year interest rate swaps are quoted at LIBOR versus the

8.0% fixed rate.

Management believes that the firm is currently​ “underrated” and that its credit rating is likely to improve in the next year or two.​ Nevertheless, the managers are not comfortable with the interest rate risk associated with using​ short-term debt.

a. Suggest a strategy for borrowing the $100.00 million. What is your effective borrowing​ rate?

b. Suppose the​ firm’s credit rating does improve three years later. It can now borrow at a spread of

0.50% over​ Treasuries, which now yield 9.10% for a​ seven-year maturity. ​ Also, seven-year interest rate swaps are quoted at LIBOR versus

9.50%.

How would you lock in your new credit quality for the next seven​ years? What is your effective borrowing rate​ now?

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