Interest rate swap The following questions are based on the case provided...
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Interest rate swap
The following questions are based on the case provided below
Able Inc. and Baker Inc. face the following borrowing costs in the fixed and floating rate markets:
FixedRate Market Floating Rate Market Preferred Type
Able 17% L + 0.20% Fixed
Baker 14% L 0.20% Floating
Each firm desires the rate other than that for which it has comparative advantage.
A dealer stands ready to enter into a swap as either a fixedrate payer or floating-rate receiver (or vice versa). The dealer will pay a fixed 15.50% against LIBOR or receive 14.50% against LIBOR. Assume that each firm borrows in the market in which it has comparative advantage and enters into a swap agreement. Analyze the potential gains from swapping for all parties under the following headlines:
a. What does the swap dealer earn?
b. Obtain the effective loan rate for Able. List all loans Able deals with.
c. By how much is Baker better-off from the swap agreement?
d. What is the overall benefit of the three parties: Able, Baker and the Dealer?
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