A&B Industries has just issued a 3-year $50 million note with floating interest rate payments based on LIBOR made annually. A&B has approached a derivatives dealer, David, to price a plain-vanilla interest rate swap to serve as a hedge on the interest payments of its debt issuance. The term structure of LIBOR over the next three years is shown below:
1-year LIBOR: 2%
2-year LIBOR: 2.5%
3-year LIBOR: 3%
a. Calculate a fair fixed-rate for a 3-year plain-vanilla interest rate swap with annual settlement dates (assuming a floating rate of LIBOR).
b. What is Rubin trying to achieve by entering into the swap (choose the best answer below)?
i. The lowest interest rate possible on its debt
ii. A fixed rate of interest on its debt
iii. A floating rate of interest on its debt
iv. That its debt value stays constant for three years