27 Floating Rate Agreement Quotes Rock Spring plc decides it wants to borrow capital for a six-month
Question:
27 Floating Rate Agreement Quotes Rock Spring plc decides it wants to borrow capital for a six-month period in two three-month instalments. The company can borrow at FRB + 2 per cent. FRB rates today are 4 per cent. However, because the firm must agree the contract in advance and pay later, it will be exposed to the risk of interest rates over the next three months, since the level of its second interest payment will not be established until the end of the first period. In order to manage this risk, the firm decides to acquire a floating rate agreement from an investment bank. The company receives the following floating rate agreement quotes:
Period Dealer 1 Dealer 2 3 vs. 6 1.8–1.85% 1.9–1.95%
3 vs. 6 1.7–1.86% 1–1.82%
6 vs. 9 2–2.3% 2.1–2.5%
6 vs. 9 3–3.5% 2.9–3.3%
9 vs. 12 3.2–3.9% 3–3.7%
9 vs. 12 3.7–4% 3.8–4.2%
Which quote should the firm use to hedge its exposure and at what interest rate?
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