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On December 20, 2017, the third Wednesday of the month, Mr. Ricardo Ricotta, a partner in Careening Calzone S.p.A., (CCS) major pasta manufacturing company is

On December 20, 2017, the third Wednesday of the month, Mr. Ricardo Ricotta, a partner in Careening Calzone S.p.A., (CCS) major pasta manufacturing company is looking at its interest rate exposure in US Dollars. CCS presently has on its books a substantial amount of medium term floating rate borrowing, approximately $100 million, at a 150 basis point spread over LIBOR. Although Mr. Ricotta is happy with the comfortable spread that had been "locked-in," especially given the low level of money market rates, he is concerned about the possibility of a rapid increase in U.S. interest rates, if the economy maintains its momentum in 2018, and the Fed hikes rates several times. In this context, Mr. Ricotta wants to examine various alternative hedging alternatives, since he feels that the economy may strengthen in 2018, following the corporate tax cut, causing the Fed to quickly raise interest rates in the coming year. However, he is not sure if this will indeed happen. Nevertheless, he wants some protection against uncertainty in the short-term interest rate environment in 2018.
Several investment banks, including Tutti Finanza S.p.A., have contacted Mr. Ricotta, suggesting hedging choices and expressing their willingness to quote prices on a variety of hedging products. Before discussing the specific quotations with them, he decides to ask his new assistant treasurer, Mr. Michele Manicotti, to do  few calculations of his own based on market data. Mr. Manicotti graduated from the undergraduate program at NYU Stern with excellent grades in all the finance courses, including the difficult course, "Futures and Options." Mr. Manicotti decides to take a close look at the problem, where your inputs are required.
Mr. Manicotti obtains the following zero-coupon interest rates from the yield curve he has constructed based on LIBOR, Eurodollar futures and swap quotes from the Bloomberg terminal:
1 yr 1.0%
2 yr 1.5%
3 yr 2.0%
4 yr 2.5%
For purposes of the calculations, all interest rates can be assumed to annual rates with annual compounding. (In other words, you do not need to worry about day-count conventions.)


Assuming that all the swaps under consideration have annual cash flows.
1. What are the current swap rates for 2 yr and 3 yr swaps?
2. If CCS swaps its existing 2 yr and 3 yr floating rate borrowing, what would its new fixed cost of debt be for each of these tenors? How should CCS executive the swap, i.e., what would they be paying and what would they be receiving to "lock in" the rate?

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Solution Sure I can help you with that 1 The current swap rates for 2 yr and 3 yr swaps can be calculated using the zerocoupon interest rates provided ... blur-text-image

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