Understanding the Savings using a Standby Letter of Credit (SLC)
A corporation is planning to issue $1,000,000 of 270-day commercial paper for an effective yield of 5%. The corporation expects to save 30 basis points on the interest rate by using either an SLC or a loan commitment as collateral for the issue:
What are the net savings to the corporation if a bank agrees to provide a 270-day SLC for an up-front fee of 20 basis points to back the commercial paper issue?
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...are charging 5% per annum. But if the CP issue is backed by a renowned bank then people would only ask for 4.7% (saving of 30 basis points=0.3%).
For backing the CP issue the bank is charging 0.2% upfront. In case of default by the company bank would repay the public and would try to recover the money from the company.
Now, there are two situations: