Reference no: EM132364998

Assignment -

Use the following case study for this assignment: Kunz, D., & Dow, B., III. (2012). Interest rate swaps at Hologen Inc.

Case Summary: INTEREST RATE SWAPS AT HOLOGEN INC

Hologen Inc., a diversified company in medical technological products, is planning on aggressively expanding its market share to become the largest global pure-play women's health company. Presently, it operates in three business segments (Skeletal Health, Breast Health, and GYN Surgical) and it is imperative to penetrate the diagnostic healthcare segment to attain its status as the world leader. Acquiring Cybertech, a British diagnostic firm, will be the quickest and most cost-effective option given its existing international clientele. Hologen requires approximately $200 million to make the tender offer for Cybertech and is considering three borrowing alternatives, and your task is to recommend the best option.

Your well-written draft should address the seven questions at the end of the case study and meet the following requirements: Be two or three pages in length total and Be formatted according to the APA guide.

THE TASK -

The investment banker helping Hologen with the Cybertech acquisition had done some preliminary research and concluded that Hologen could raise $200 million dollars by issuing a 5% coupon bond (paid semi-annually) at face value with a maturity of 10 years. However, the investment banker also noted that at present, there was considerably more client interest in funding investment grade floating rate notes. Given Hologen's A-rated credit quality, they could borrow $200 million for 10 years at a floating rate of 6-month LIBOR plus 1.5% with interest paid semi-annually. Tim Scott suggested that the riskiness of the international acquisition would lead Rollins to prefer fixed rate debt, even if floating rate debt is relatively more attractive at the present time. The investment banker suggested Scott should seriously consider the floating rate debt and he would try to find an appropriate party for an interest rate swap in order to take advantage of the current high demand for floating rate debt. Scott was a little uncertain about interest rate swaps but his investment banker assured him that the interest rate swap is more common that he might think. He remarked that the notional principal for interest rate swaps have grown from $12.8 trillion in 1995, to $48.8 trillion in 2000, to $128 trillion in 2005, to about $347 trillion in 2010. As interest rate swaps become more and more common place in the financial markets, the investment banker suggested Scott should stronger consider this possibility.

Two days later, the investment banker called Scott and reported that he found a company, LC Inc. who is able to borrow $200 million at a fixed rate of 6.1% for 10 years but prefers floating rate debt to take advantage of the steep upward sloping yield curve and initially lower interest payments. Unfortunately LC Inc. is just below investment grade in terms of credit quality and they are not able to fully take advantage of current favorable market conditions for floating rate debt. It would cost LC Inc. 6-month LIBOR plus 3.4% to borrow in the floating rate market.

The investment banker suggests Hologen and LC Inc enter into an interest rate swap that can be set up by National Bank who will act as a dealer in the interest rate swap. Hologen will pay National Bank a fixed 3.1% interest on $200 million dollars over 10 years in exchange for the 6-month LIBOR rate interest on $200 million. National Bank will also have an agreement with LC Inc. LC Inc will pay National Bank 6-month LIBOR rate interest on $200 million in exchange for a fixed rate of 3% interest. The cost of financing for Hologen and LC Inc as well as the swap terms are summarized below:

Tim Scott went back to his office to prepare a presentation of the three different alternatives available to Hologen in terms of raising the $200 million needed for the acquisition. Scott must include the details of the fixed rate bond, floating rate note and interest rate swap in such a manner that Rollins and the Board would be able to make an informed decision. Scott listed a few major discussion points that needed to be covered in his presentation. Considering that Rollins and the Board would almost certainly want to borrow at a fixed rate, Scott had to make sure his presentation explained in some detail why it would be better for Hologen to issue a floating rate note and engage in an interest rate swap.

1) Why might investors prefer floating rate notes over a fixed rate bond?

2) Why might Hologen prefer to issue fixed rate bonds rather than floating rate notes?

3) What is the anomaly in current market conditions that makes an interest rate swap a viable option for both parties involved in the swap?

4) If Hologen issues a floating rate note and engages in the interest rate swap, what is the net cost of financing for Hologen after the interest rate swap? How does this compare to the cost of financing if Hologen issues a fixed rate bond?

5) If LC Inc issues a fixed rate bonds and engages in the interest rate swap, what is the net cost of financing for LC Inc. after the interest rate swap? How does this compare to the cost of financing if LC Inc issues a floating rate note?

6) What is National Bank's role in the interest rate swap and how much will they be compensated for their involvement in this transaction?

7) How does the interest rate swap reduce the cost of borrowing for both parties and allow the intermediary to be compensated?

Attachment:- Directions and Case Study Files.rar