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. Heather has just made an interest payment today, so the next payment is due six months from today.
Heather finds that she can swap her current floating rate payments for fixed payments of 7.00% per annum. (CB Solutions's weighted average cost of capital is 12%, which Heather calculates to be 6% per six month period, compounded semiannually).
Required:
a. If LIBOR rises at the rate of 50 basis points per six month period, starting tomorrow, how much does Heather 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 Heather save or cost her company by making this swap?