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A corporate treasurer tells you that he has just negotiated a 5-year loan at a
Chapter 7, Problem 7.7(choose chapter or problem)
A corporate treasurer tells you that he has just negotiated a 5-year loan at a competitive fixed rate of interest of 5.2%. The treasurer explains that he achieved the 5.2% rate by borrowing at 6-month LIBOR plus 150 basis points and swapping LIBOR for 3.7%. He goes on to say that this was possible because his company has a comparative advantage in the floating-rate market. What has the treasurer overlooked?
Questions & Answers
QUESTION:
A corporate treasurer tells you that he has just negotiated a 5-year loan at a competitive fixed rate of interest of 5.2%. The treasurer explains that he achieved the 5.2% rate by borrowing at 6-month LIBOR plus 150 basis points and swapping LIBOR for 3.7%. He goes on to say that this was possible because his company has a comparative advantage in the floating-rate market. What has the treasurer overlooked?
ANSWER:Step 1 of 2
Debt risk is the risk of a defaulter not paying the loan or debt obligation. It disrupts the financial institution's cash inflows for not paying the loan amount, which increases the cost of collecting such payments. Excess cash inflows and outflows can be recorded to provide additional cover on credit risk. If the lender is faced with high credit risk, it can be reduced by a higher coupon amount, which provides greater cash flow.