612 CHAPTER 16. INTERNATIONAL FIXED-INCOME MARKETS
rate. If the normal all-in market rate on a fixed-rate loan with the same life and
default risk as the floating-rate loan is 6 percent, the equivalent annuity (EqAn) of
usd425,000 up-front is determined as follows:
EqAn: 425,000 =
eqAn
1 +y+
eqAn
(1 +y)^2+...+
eqAn
(1 +y)^5,
= eqAn× 4 .212367;
⇒eqAn =425 , 000
4. 212367
= 100, 893. 47 (16.3)
Thus, the up-front fee is equivalent to a spread of 100,893.47/10,000,000, that is,
about 1 percentp.a.
If you ever have to do sums like this on a no-frills calculator, the shortcut to re-
member is
1
1 +y
+
1
(1 +y)^2+...+
1
(1 +y)n=
1 −(1 +y)−n
y. (16.4)
DoItYourself problem 16.3
If you would apply the approach of the last example to the one before, you would
have found an equivalent spread of 1.0089 percent, not the 1.0092 of the earlier ex-
ample. Why is there a difference? Which would you think the best figure (assuming
anybody would bother about differences so tiny as this one)?
Credit Lines
In addition to outright loans, eurobanks also offer standby credits. These come in
two forms:
- A standard line of credit (or credit line) of, say,gbp100m gives the beneficiary
the right to borrow up togbp100m, at the prevailing interest rate plus a
preset spread. The difference between a credit line and a loan is that with a
credit line the company is not forced to actually borrow the money: money is
drawn downonly if and when it is needed, and paid back at any date prior to
the expiry date. Interest (in the strict sense) is payable only on the portion
actually used, while on the unused funds only acommitment feeof 0.125 to 1
percentp.a.needs to be paid.
A credit line is, in principle, a short-term commitment—say, three months. In
practice, a credit line tends to get extended, but this is not an automatic right
to the creditor. Unless stated otherwise, the credit line can be revoked by the
bank if there are substantial changes in the creditor’s credit standing. - Under arevolving commitment, the creditor has the irrevocable right to borrow
up to a stated limit, at the then-prevailing rate plus a preset spread during
an agreed-upon period of (usually) several years. For instance, a borrower