The MEJ Development Company is constructing a $300 million office park development that it anticipates completing in two years. At the project’s completion, the company plans to refinance its short-term construction and development loans by borrowing $300 million through the private placement of 10-year bonds. The MEJ Company has a BBB quality rating and its option-free, fixed-rate bonds trade 200 basis points above comparable Treasury bonds and its floating-rate bonds trade at 150 basis points above the LIBOR. Currently, 10-year T-bonds are trading to yield 6%. With current rates considered relatively low, MEJ is expecting interest rates to increase and would like to lock in a rate on the 10-year, fixed-rate bond two years from now. The company is considering locking in its rate by entering a forward swap with Star Bank. Star is willing to provide MEJ a two-year forward swap agreement on a 10-year, 7.25%/LIBOR swap.

a. Explain the forward swap position that MEJ would need to take in order to lock in the rate on its 10-year, fixed-rate bond to be issued two years from now.

b. Given MEJ hedges with a swap position, explain how it would obtain a fixed rate for 10 years at the forward swap’s expiration date by issuing its floating rate notes at LIBOR plus 150 bp. What is the fixed rate MEJ would have to pay on its position?