Bob is asking for an explanation. He has left you a note on your desk.

A note from Bob:

Im still not entirely comfortable with the debt issuance and hedging using the futures. Im also concerned because weve been offered a $20 million commercial loan priced using 3-month Libor index+100bp. My concern is that most of the companys assets are generating fixed-rate returns. I decided to explore a swap possibility.

After some preliminary research, using a money center banks swap trading desk and its traders connections, a possible deal has started taking shape. Another company would be willing to pay our company a floating rate payment priced at 3-month Libor+25bp, while our company would have an obligation to pay a fixed rate of 5.55% annualized, with quarterly settlements. Im not overly concerned with the other partys reasons for requiring these payments, so we dont have to calculate the other partys final cost. But we do need to remember that fixed-rate swap payments are made on a semiannual basis, based on 30/90/180/360 Accrual Year Fraction, while floating-rate side payments are being made on a quarterly basis, based on Actual/360 Accrual Year Fraction.

Id like you to calculate what would be the ultimate cost of the loan to our company. For the purpose of this assignment you may ignore the carrying costs and the brokerage fees of the swap arrangement.

Deliverables

1. The basis of the ultimate cost of the payment to the lender to our company.