Fixed and Floating rate Harvard Case Solution & Analysis

Fixed and Floating rate Case Solution


The investment decision should be made from the fixed rate and floating rate from the 100 million par that has $102 par value of fixed rate, which is offered at 2.6% coupon rate. Moreover,another rate that is three years 100 million that has floating rate note of about 101.9, which offers three-month LIBOR and 1.25% rate. Another alternative of the investment is to invest at the interest rate swap in which purchases are made at the payment of 1.32% plus three months LIBOR, and payment is received at 1.29% plus three month LIBOR.

1.      Derive IRR from fixed & floating-rate notes

The internal rate of return (IRR) measures the profitability of a potential investment. It shows the discount rate that is used to get better investment return after a certain period. As per the case, the customer has to make the better purchase decision based on fixed rate and floating rates based on the internal rate of return of fixed and floating rate notes.

The Fixed rate IRR

Initial Investment: As the company has the fair value of $ 100 million with 100 par values, the benchmark par value of every investment is $10 par value then, the total initial investment is divided by 10 par value, and the resulted amount is divided by total par value which is 100 par value in case of fixed rate, after which it is multiplied to its coupon payment as shown in the IRR calculation. The initial investment is calculated as $ -102,600.

Cash flows: The fixed rate is calculated on the basis of semiannual payment by dividing the coupon payment by two that resulted in 1.3% rate in every half year. The cash flows are discounted at semiannual fixed rate multiplied by its number of years, which gives the different present value at each year, and cumulative present value of cash becomes $ 76,261.

IRR: Internal rate of return (IRR) is calculated at the -8% rate. As it is fixed rate, therefore there would be the loss to the investor as the investor has to pay fixed amount rate even if there is change is inflation rate and market rate.

The Floating Rate IRR:

Initial investment: Initial investment is calculated in the same manner as it is calculated in the case of fixed rate, the only difference is that the fixed rate was divided by the par value of 100 because of fixed rate, but floating rate is divided by 101.9 par value as it has the ability to change because of change in inflation rate. It resulted in an initial investment of -98,135 as floating rate investment note.

Cash Flows: The floating rate is based on three months Libor and 1.25% rate. The three-months labor is estimated as given in data (Excel file) and the difference change is incorporated in its labor calculation plus discount factor of 1.25% is used to calculated the discount factor that resulted in the cumulative present value of cash flows quarterly of $ 407,289.

IRR:  The floating rate IRR results in 29% as per the calculated present value and its initial investment. It shows that the investor has the advantage if he invests in floating rate as he gets the fixed rate of 1.25% plus the three months LIBOR as per the change in economic situations. Sometimes it may get worse however,it will not lead to the loss of the investor as he/she will be getting 1.25% fixed.

2.      Convert fixed to float and floating to fix via swap.  Is there any value?

The Swap is determined by its payment received and paid based on its different rates. As per the situation, the ask price 1.32% and bid price is 1.29%..................

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