Interest Rate Swap Analysis for XYZ Corporation

Very Hard Derivative Strategies Swap Strategies

XYZ Corporation is considering implementing a derivative strategy that involves interest rate swaps to manage its exposure to floating interest rates. The company's CFO, who is experienced in capital markets, is evaluating whether to enter into a receive-fixed, pay-floating interest rate swap for a notional amount of $10 million, aiming to reduce the overall effective interest rate on its debt portfolio.

The current market interest rate for the floating leg is LIBOR + 1%, and the fixed rate negotiated for the swap is 3%. The CFO anticipates that interest rates will rise significantly over the next few years.

Considering the company’s outlook on interest rates and their current debt profile, which of the following statements is most accurate regarding the rationale and outcome of entering into this interest rate swap?

By entering into the receive-fixed, pay-floating swap, XYZ Corporation will likely benefit from stable cash flows as rates rise, while effectively locking in borrowing costs.

This swap will result in greater interest expenses for XYZ Corporation when rates increase; thus, it is an inappropriate strategy given the market's upward rate trajectory.

The swap allows XYZ Corporation to gain credit exposure to the floating rate environment while capturing the potential benefits of decreased financing costs.

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