can anyone with example explain how I spread is of use to an issuer to determine relative cost of fix rate borrowing vs floating rate borrowing - as stated in advantages of I spread: Reading 14
- Fixed-Rate Borrowing:
- The issuer is considering issuing a 10-year fixed-rate bond.
- They calculate the I-spread for the fixed-rate bond by comparing its yield to the yield of a benchmark bond with similar characteristics but a different coupon rate, such as a government bond or a highly-rated corporate bond.
- The I-spread for the fixed-rate bond is determined to be 1.5%.
- Floating-Rate Borrowing:
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The issuer is also considering issuing a 10-year floating-rate bond linked to a reference rate, such as Libor.
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They calculate the I-spread for the floating-rate bond by comparing its yield to the yield of the same benchmark bond used for the fixed-rate bond.
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The I-spread for the floating-rate bond is determined to be 0.8%.
- Relative Cost Assessment:
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Comparing the I-spreads, the issuer finds that the I-spread for the fixed-rate bond (1.5%) is higher than the I-spread for the floating-rate bond (0.8%).
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This suggests that, in terms of relative cost, the floating-rate borrowing option is more favorable for the issuer.
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The lower I-spread for the floating-rate bond indicates that the borrowing cost associated with floating-rate borrowing is relatively lower compared to fixed-rate borrowing.