This question is based on Popova and Simkins: "The Value of OTC...
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This question is based on Popova and Simkins: "The Value of OTC...
This question is based on Popova and Simkins: "The Value of OTC Derivatives: Case Study Analyses of Hedges by Publicly Traded Non-Financial Firms" ISDA research paper, 2014. http://www2.isda.org/functional-areas/research/studies/ You are the treasurer of Hilton Hotels (hereafter referred to as Hilton). During the period of the interest rate swap, Hilton together with its subsidiaries, owned and operated 60 hotels; leased and operated or managed 203 hotels about 3,000 hotels owned by others. Hilton had issued $375 million fixed-rate senior notes that made semiannual payments based on an (annual) 7.95% coupon. Subsequently, interest rates fell substantially, and Hilton wanted to take advantage of the low interest rate environment and swap its fixed interest payments for floating-rate payments. Hilton can enter a swap that will exactly match its remaining fixed coupon payments. Under the terms of the 5-year swap, the fixed rate payer will pay an annual rate of 7.95% on $375 million, and the floating rate payer will pay the six-month LIBOR rate plus 415 basis points. (Recall, the difference between the payments is paid semiannually.) How can you convert your corporation's fixed-rate debt into a synthetic floating rate debt? What is the annual synthetic floating-rate that your corporation will pay?
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