Q. Recall that is the economy continues to be strong; ABC Company may need to increase its production by about 50 percent over the next few years demand to satisfy. It would need financing to expand and accommodate the increase in production. Recall that the yield curve is currently upward sloping. Also recall that ABC is concerned about a possible slowing of the economy because of potential Fed actions to reduce inflation. ABC currently relies mostly on commercial loans with floating interest rates for its debt financing. It has contacted Blazo Bank about the use of interest rate derivatives to hedge the risk.

Explain how could ABC use interest rate swaps to reduce the exposure of its cost of debt to interest rate movements and what is a possible disadvantage of ABC using the interest rate swap hedge as opposed to no hedge?