Answer Happy

The 3 year USD bond issued by Company A has coupon of 11.5%,
which the company thinks is too high. In fact the bond price
has since risen substantially and current yield is 9.5%. The
company thinks due to recent successful fund raising, interest
rate will fall. Hence it wants to do interest rate swaps to
change the payment from fixed rate to floating rate.
Assuming that a bank is willing to do the trade up to USD
notional of 1 million USD, it needs to consider the following
facts to quote a price. Please give your best estimate, and
rationale.
1. With the current 3 year USD swap rate of 1.4%, and bank
receives the 11.5% coupon (payment is every 6 months, what is
the Company’s credit risk premium?
2. If the Bank pays the Company 11.5% fixed rate to cover the
coupon payment, what is the fair price the Company needs to
pay the bank (assuming that the floating rate index is the 6 month
Libor rate, currently at 1.72%)?
3. Please consider the credit risk premium the bank need to
charge Company A in case the economy in the next 3 years does
not favor the Company’s business. Please write down your arguments
for your quote to the Company of the swap premium
(6 month Libor rate + premium is what the Company needs to pay
to the Bank).