Consider Firms A and B; each firm wants to borrow $40 million for three years....
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Consider Firms A and B; each firm wants to borrow $40 million for three years. Firm A wants to finance an interest-rate-sensitive asset and therefore wants to borrow at a floating rate. A has good credit and can borrow at LIBOR. Firm B wants to finance an interest-rate-insensitive asset and thus wants to borrow at a fixed rate. B has less-than-perfect credit and can borrow fixed at 5.5%. Borrowing Costs Firm A Firm B Fixed $5% $5.5% Floating LIBOR LIBOR +0.2% Let's say these two firms can conduct a Swap agreement by using a Swap Bank. The Swap Bank has these quotes (against LIBOR): Bid Ask 5.20% 3-years 5.10% a) Based on the figure below, how much does Firm A pay the Swap Bank, receive from the Swap Bank and Pay Bank X? (7 points) b) Based on the figure below, how much does Firm B pay the Swap Bank, receive from the Swap Bank and Pay Bank Y? (7 points) c) How much do firms A and B save relative to borrowing at their respective rates directly from the bank? (6 points) At Time t=1 (use LIBOR = 3%) 5.1% 5.2% Firm A Fimm B Swap Bank LIBOR LIBOR 5% LIBOR +0.2% Bank X Bank Y
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