Consider two hypothetical companies, X and Y. Companies X and Y have been offered the...
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Consider two hypothetical companies, X and Y. Companies X and Y have been offered the following rates per annum on a $10 million 5-year investment. Company X: Floating LIBOR+0.5% , fixed-rate: 8%. Company Y: Floating LIBOR+1% Fixed: 9.2% Company X prefers a floating-rate loan for the investment; company Y prefers a fixed-rate loan. X borrows at a fixed rate to reduce financing costs, while Y borrows at a floating rate.
1. Design a swap that will net a bank, acting as an intermediary, 0.2% per annum, and appear equally attractive to X and Y. Why is such an arrangement possible? A)
2. Design a swap contract such that company X has 0.4% interest savings and company Y has 0.3% interest savings. Compared with A), what is the risk associated with this swap arrangement?
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