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Problem 3: (10 points) Swaps Suppose that two companies, Etisalat and DU both wish to...

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Finance

Problem 3: (10 points) Swaps

Suppose that two companies, Etisalat and DU both wish to borrow $1 million for 5 years and have been offered the rates shown in below:

Etisalat Fixed 4.0 Floating L 0.4

DU Fixed 6.0 Floating L + 0.6

Etisalat has a AAA credit rating; DU has a BBB credit rating. We assume that DU wants to borrow at a fixed rate of interest, whereas Etisalat wants to borrow at a floating rate of interest linked to 6-month LIBOR. DU Corp pays a higher rate of interest than AD Corp in both fixed and floating markets.

  1. Which company has comparative advantage in Floating rates and Fixed rates? WHY?
  2. What will be net benefit for both companies if they engage in SWAP transaction? (in $)
  3. Draw the SWAP diagram between the two companies indicating the Cash Flows in and out
  4. What will be the NET benefit for Etisalat, and NET benefit for DU by executing this SWAP.
  5. If a Bank is involved in executing this swap and collects 0.2% commission, redraw the SWAP diagram in part d).

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