Pearce Rider Corp. (PRC) has a long-term loan for $500,000 that is due in 15 years and has a variable interest rate based on the prime rate (currently at 4%) plus 2.75%. The terms of the loan CANNOT be renegotiated, but PRC would prefer to pay a fixed interest rate on this loan. PRC's chief financial officer has suggested that PRC enter into a swap agreement with a dealer. The dealer has offered an arrangement whereby PRC will pay a fixed interest rate of 7% on the notional amount of $500,000. The dealer agreed to pay a variable interest rate of prime plus 2.75%. Required: a) Show all the cash flows both to and from the dealer related to the loan and the swap arrangement for PRC for one month, assuming the prime interest rate stays at its current rate. b) Show all the cash flows both to and from the dealer related to the loan and the swap arrangement for PRC for one month, assuming the prime interest rate increases to 4.5%. , c) Describe which risk PRC is exposed to and what PRC has accomplished by entering into the swap arrangement.
Pearce Rider Corp. (PRC) has a long-term loan for $500,000 that is due in 15 years and has a variable interest rate based on the prime rate (currently at 4%) plus 2.75%. The terms of the loan CANNOT be renegotiated, but PRC would prefer to pay a fixed interest rate on this loan. PRC's chief financial officer has suggested that PRC enter into a swap agreement with a dealer. The dealer has offered an arrangement whereby PRC will pay a fixed interest rate of 7% on the notional amount of $500,000. The dealer agreed to pay a variable interest rate of prime plus 2.75%. Required: a) Show all the cash flows both to and from the dealer related to the loan and the swap arrangement for PRC for one month, assuming the prime interest rate stays at its current rate. b) Show all the cash flows both to and from the dealer related to the loan and the swap arrangement for PRC for one month, assuming the prime interest rate increases to 4.5%. , c) Describe which risk PRC is exposed to and what PRC has accomplished by entering into the swap arrangement.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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