The following table shows the borrowing opportunities for two firms
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interest_rate_swap1.docThe following table shows the borrowing opportunities for two firms.
|
|
Firm A |
Firm B |
|
Fixed rate |
11.75 % |
9.5% |
|
Floating rate |
LIBOR + 0.75% |
LIBOR |
Firm A can raise the money by issuing 5-year floating-rate notes at LIBOR + 0.75 %. However, Firm A would prefer to borrow at a fixed rate. On the other hand, Firm B is considering issuing 5-year fixed-rate Eurodollar bonds at 9.5 percent. It would make more sense for Firm B to issue floating-rate notes at LIBOR in order to finance floating-rate Eurodollar loans. Finally, the swap bank makes the following offers to both firms.
Interest Rate Swap
Swap
Bank
Firm
A
11 1/2%
LIBOR + 1%
LIBOR -1/4%
9 3/4%
Firm
B
a) What is the gain for each party: the Swap Bank, Firm A, and Firm B based on the QSD? Show your work. (40points)
b) Firm A and B face the same financing option as the above table. However, the Swap Bank offers a new LIBOR financing as in the table below. That is, the Swap bank provides two firms with LIBOR rate only. If Firm A gains 0.50% from this swap, figure out the ask price for LIBOR. What are the gains for the Swap Bank and Firm B, respectively? Show your work. (90points)
|
U.S. $ |
Bid |
Ask |
|
5 year |
10.00 % |
( )% |
