Question
QUESTION FOUR GUM Plc is a Stock Exchange listed company that produces and distributes hydro-electricity. As a result of a deficit in hydro-electricity power, GUM
QUESTION FOUR GUM Plc is a Stock Exchange listed company that produces and distributes hydro-electricity. As a result of a deficit in hydro-electricity power, GUM Plc plans to raise additional finance for the construction of a hydro-electricity power station. GUM Plc is only able to raise the required finance of $400 million through a five year Eurobond at an annual floating rate of Spot yield curve rate plus 80 basis points, with a nominal value and redemption value of $100 per bond. The spot yield curve rates will be derived from the current government bonds which mature at one year intervals of time from one year to five years. Each of the government bonds has a nominal value of $100 and a fixed annual coupon rate. Each bond is redeemable at its nominal value. The other information about the bonds is summarized in the table below: Bond Annual coupon rate Term to maturity price Page 5 of 9 Bond 1 4.50% 1 year $101.25 Bond 2 4.75% 2 years $101.80 Bond 3 5.25% 3 years $102.75 Bond 4 5.75% 4 years $103.25 Bond 5 5.80% 5 years $103.80 GUM plc is concerned that it would become expensive to continue servicing the debt because of the expected rise in interest rates. GUM Plc is therefore proposing to swap the floating rate interest payment to a fixed rate payment. FRUITEX Bank Plc has offered GUM Plc an interest rate swap. Under this swap, GUM Plc would pay FRUITEX Bank based on a fixed interest rate of 5.765% in exchange for receiving a variable amount of interest based on the current yield curve rate. Payments are receipts are expected to be made at the end of each year for the next five years. The bank will guarantee the swap and charge an annual fee of 25 basis points if the swap is agreed. Required: (c) Based on the information provided in the scenario and your calculated spot and froward rates for the 5 year period, calculate the amounts that GUM Plc expects to receive or pay under the swap every year.
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