GUM Plc is a Stock Exchange listed company that produces and distributes hydro-electricity. As a result of a deficit in
Posted: Mon Nov 15, 2021 4:58 pm
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:
(a) Calculate the annual spot yield rates for years one, two,
three, four and five by boot strapping the coupon paying bonds. [10
Marks]
(b) Calculate the annual forward rates for year two, year three,
your four and year five from the annual spot yield rates calculated
above. [4 Marks]
(c) Based on the information provided in the scenario and your
results in parts (a) and (b) above, calculate the amounts that GUM
Plc expects to receive or pay under the swap every year.
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:
(a) Calculate the annual spot yield rates for years one, two,
three, four and five by boot strapping the coupon paying bonds. [10
Marks]
(b) Calculate the annual forward rates for year two, year three,
your four and year five from the annual spot yield rates calculated
above. [4 Marks]
(c) Based on the information provided in the scenario and your
results in parts (a) and (b) above, calculate the amounts that GUM
Plc expects to receive or pay under the swap every year.