Problem 8.

1 T-Bill Yields 2009

The interest yields on U.S. Treasury securities in early 2009 fell to very low levels
as a result of the combined events surrounding the global financial crisis. Calculate
the simple and annualized yields for the 3-month and 6-month Treasury bills
auctioned on March 9, 2009 listed here.

Assumptions 3-Month T-Bill 6-Month T-Bill

Treasury bill, face value $10,000.00 $10,000.00

Price at sale $9,993.93 $9,976.74

a. Discount on sale $6.07 $23.26

Discount on sale is the difference between the face value of the security and the
price it is sold at auction.

b. Simple yield 0.0607% 0.2331%

Simple yield is found by dividing the discount (the dollar return to the investor on
maturity) by the price paid on purchase.

c. Annualized yield 0.2432% 0.4668%

Annualized yield is found by compounding the simple yield by the number of

periods per year. In this case a 3-month T-Bill is assumed to have a 90 day maturity
within a 360 day interest rate year (U.S. dollar practices).
Problem 8.3 Stapleton’s Mortgage

Frank Stapleton pays £406,000 for a four-bedroom bungalow on the outskirts of Edinburgh, Scotland. He plans to make a
20% down payment but is having trouble deciding whether he wants a 15-year fixed rate (3.650%) or a 30-year fixed rate
(4.565%) mortgage.

Assumptions 15-Year Mortgage 30-Year Mortgage

Price of house at purchase £406,000 £406,000
Less down-payment (20%) -£81,200 -£81,200
Mortgage principal (£) £324,800 £324,800
Mortgage length (years) 15 30
Mortgage length (months) 180 360
Fixed rate of interest 3.650% 4.565%

a. What is the monthly payment for both the 15- and 30-year mortgages, assuming a fully amortizing loan of
equal payments for the life of the mortgage? Use a spreadsheet calculator for the payments.

Monthly payment (amortizing loan, all equal payments) £2,346 £1,658

This is calculated using Excel's PMT formula. Note how much higher, roughly 41.5%, the payments are for a 15-year
mortgage over a 30-year mortgage.

b. Assume that instead of making a 20% down payment, he makes a 15% down payment, finances
the remainder at 5.785% fixed interest for 15 years. What is his monthly payment?

Assumptions 15-Year Mortgage

Price of house at purchase £406,000.00
Less down-payment (10%) 15% -£60,900.00
Mortgage principal (US$) £345,100.00
Mortgage length (years) 15
Mortgage length (months) 180
Fixed rate of interest 5.785%

Monthly payment £2,872.22

c. Assume that the bungalow’s total value falls by 30%. If Frank sells the house at the new market value, what
will be his gain or loss on the home and mortgage, assuming all the mortgage principal remains? Use the same
assumptions as in part (a).

Home's original value £406,000.00 £406,000.00

Fall in value -30.0% -30.0%
New home market value £284,200.00 £284,200.00

Mortgage outstanding £324,800.00 £324,800.00

Gain/loss on sale of house against mortgage alone -£40,600.00 -£40,600.00

If the homeowner wanted to be assured of not selling the home at less than the mortgage outstanding, he would have to
price it at £324,800. At that price, given a market which now thinks it is only worth £284,200, the homeowner is going to
have a big problem selling it. Much longer to sell, if ever.
Problem 8.4 BBC (Australia)

Botany Bay Corporation (BBC) of Australia seeks to borrow US$30,000,000 in the Eurodollar market. Funding is needed for two years.
Investigation leads to three possibilities. Compare the alternatives and make a recommendation.

#1. Botany Bay could borrow the US$30,000,000 for two years at a fixed 5% rate of interest
#2. Botany Bay could borrow the US$30,000,000 at LIBOR + 1.5%. LIBOR is currently 3.5%, and the rate would be reset every six
months
#3. Botany Bay could borrow the US$30,000,000 for one year only at 4.5%. At the end of the first year Botany Bay would have to
negotiate for a new one-year loan.

Assumptions Values
Principal borrowing need $ 30,000,000
Maturity needed, in years 2.00
Fixed rate, 2 years 5.000%
Floating rate, six-month LIBOR + spread
Current six-month LIBOR 3.500%
Spread 1.500%
Fixed rate, 1 year, then re-fund 4.500%

First 6-months Second 6-months Third 6-months Fourth 6-months

#1: Fixed rate, 2 years
Interest cost per year $ 1,500,000 $ 1,500,000
Certainty over access to capital Certain Certain Certain Certain
Certainty over cost of capital Certain Certain Certain Certain

#2: Floating rate, six-month LIBOR + spread

Interest cost per year $ 750,000 $ 750,000 $ 750,000 $ 750,000
Certainty over access to capital Certain Certain Certain Certain
Certainty over cost of capital Certain Uncertain Uncertain Uncertain

#3: Fixed rate, 1 year, then re-fund

Interest cost per year $ 1,350,000 ??? ???
Certainty over access to capital Certain Certain Uncertain Uncertain
Certainty over cost of capital Certain Certain Uncertain Uncertain

Only alternative #1 has a certain access and cost of capital for the full 2 year period.
Alternative #2 has certain access to capital for both years, but the interest costs in the final 3 of 4 periods is uncertain.
Alternatvie #3, possessing a lower interest cost in year 1, has no guaranteed access to capital in the second year.
Depending on the company's business needs and tolerance for interest rate risk, it could choose between #1 and #2.
Problem 8.5 DaimlerChrysler Debt

Chrysler LLC, the now privately held company sold-off by DaimlerChrysler, must pay floating rate interest
three months from now. It wants to lock in these interest payments by buying an interest rate futures contract.
Interest rate futures for three months from now settled at 93.07, for a yield of 6.93% per annum.

a. If the floating interest rate three months from now is 6.00%, what did Chrysler gain or lose?
b. If the floating interest rate is 8.00% three months from now, what did Chrysler gain or lose?

Assumptions Values
Interest rate futures, closing price 93.07
Effective yield on interest rate futures 6.930%

Three Months From Now

Floating Rate is Floating Rate is
Chrysler's interest rate payments with futures 6.000% 8.000%

Interest payment due in three months 6.000% 8.000%

Sell a future (take a short position) -6.930% -6.930%
Gain or loss on position -0.930% 1.070%
Loss Gain
Problem 8.6 O'Reilly and CB Solutions

Heather O'Reilly, the treasurer of CB Solutions, believes interest rates are going to rise, so she wants to swap her future floating
rate interest payments for fixed rates. At present she is paying LIBOR + 2% per annum on $5,000,000 of debt for the next two
years, with payments due semiannually. LIBOR is currently 4.00% per annum. Ms. O'Reilly has just made an interest payment
today, so the next payment is due six months from today.

Ms. O'Reilly finds that she can swap her current floating rate payments for fixed payments of 7.00% per annum. (CB
Solution’s weighted average cost of capital is 12%, which Ms. O'Reilly calculates to be 6% per six month period, compounded
semiannually).

a. If LIBOR rises at the rate of 50 basis points per six month period, starting tomorrow, how much does Ms. O'Reilly save or
cost her company by making this swap?

b. If LIBOR falls at the rate of 25 basis points per six month period, starting tomorrow, how much does Ms. O'Reilly save or
cost her company by making this swap?

Assumptions Values
Notional principal $ 5,000,000
LIBOR, per annum 4.000%
Spread paid over LIBOR, per annum 2.000%
Swap rate, to pay fixed, per annum 7.000%

First Second Third Fourth

Interest & Swap Payments 6-months 6-months 6-months 6-months

a. LIBOR increases 50 basis pts/6 months 0.500%

Expected LIBOR 4.500% 5.000% 5.500% 6.000%

Current loan agreement:

Expected LIBOR (for 6 months) -2.250% -2.500% -2.750% -3.000%
Spread (for 6 months) -1.000% -1.000% -1.000% -1.000%
Expected interest payment -3.250% -3.500% -3.750% -4.000%

Swap Agreement:
Pay fixed (for 6-months) -3.500% -3.500% -3.500% -3.500%
Receive floating (LIBOR for 6 months) 2.250% 2.500% 2.750% 3.000%

Net interest (loan + swap) -4.500% -4.500% -4.500% -4.500%

Swap savings?
Net interest after swap $ (225,000) $ (225,000) $ (225,000) $ (225,000)
Loan agreement interest (162,500) (175,000) (187,500) (200,000)
Swap savings (swap cost) $ (62,500) $ (50,000) $ (37,500) $ (25,000)

b. LIBOR decreases 25 basis pts/6 months -0.250%

Expected LIBOR 3.750% 3.500% 3.250% 3.000%

Current loan agreement:

Expected LIBOR (for 6 months) -1.875% -1.750% -1.625% -1.500%
Spread (for 6 months) -1.000% -1.000% -1.000% -1.000%
Expected interest payment -2.875% -2.750% -2.625% -2.500%

Swap Agreement:
Pay fixed (for 6-months) -3.500% -3.500% -3.500% -3.500%
Receive floating (LIBOR for 6 months) 1.875% 1.750% 1.625% 1.500%

Net interest (loan + swap) -4.500% -4.500% -4.500% -4.500%

Swap savings?
Net interest after swap $ (225,000) $ (225,000) $ (225,000) $ (225,000)
Loan agreement interest (143,750) (137,500) (131,250) (125,000)
Swap savings (swap cost) $ (81,250) $ (87,500) $ (93,750) $ (100,000)

In both cases CB Solutions is suffering higher total interest costs as a result of the swap.
Problems 8.8 Saharan Debt Negotiations

The country of Sahara is negotiating a new loan agreement with a consortium of international banks. Both sides have a tentative agreement on the
principal -- $220 million. But there are still wide differences of opinion on the final interest rate and maturity. The banks would like a shorter loan,
4 years in length, while Sahara would prefer a long maturity of 6 years. The banks also believe the interest rate will need to be 12.250% per annum,
but Sahara believes that is too high, arguing for 11.750%.

Loan 0 Payments 1 2 3 4 5 6
Principal $220 Interest (26.950) (23.650) (19.946) (15.788) (11.120) (5.881)
Interest rate 12.250% Principal (26.939) (30.239) (33.943) (38.101) (42.769) (48.008)
Maturity (years) 6.0 Total (53.889) (53.889) (53.889) (53.889) (53.889) (53.889)

a. What would the annual amortizing loan payments be for the bank consortium's proposal?

If the maturity in years is shortened to 4.0 years, the amortized payment rises to: 72.813

b. What would the annual amortizing loan payments be for Sahara's loan preferences?

If the maturity is kept at 6.0 years, and the interest rate lowered to 11.75%, the amortized payment is: 53.131

c. How much would annual payments drop on the bank consortium's proposal if the same loan was stretched out from 4 to 6 years?

Payments would fall from 72.813 to 53.889, a difference of: 18.924