FE Company wishes to raise $1,000,000 with debt financing. The treasurer of FE Company considers two possible instruments:
i. A 2-year floating-rate note at 1% above the 1-year dollar LIBOR rate on which interest is paid once a year
ii. A 2-year bond with an interest rate of 5%
Currently, the dollar LIBOR is 1.50%.
a. Is it obvious which security the Treasurer should pick?
b. Suppose the Treasurer believes that the 1-year LIBOR rate 1 year from now will rise to 4.50%. Which security has the lowest expected AIC if borrowing fees are similar for the two instruments?