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Suppose that ABC Corp and XYZ Inc are looking to borrow $350,000 and can issue...

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Accounting

  1. Suppose that ABC Corp and XYZ Inc are looking to borrow $350,000 and can issue 2-year debt at the following market rates:

Firm

Market

Rate

ABC

Fixed

4.8%

ABC

Floating

LIBOR + 3.1%

XYZ

Fixed

6.3%

XYZ

Floating

LIBOR + 5.2%

Suppose that Citigroup is offering a 1.3%/1.6% bid-ask spread on two-year swaps. That is, they are offering to be the fixed payer in a 2-year swap at a rate of 1.3% APR and a floating payer in a swap with a rate of 1.6% APR. Suppose also that ABC Corp wishes to borrow at a fixed rate while XYZ Inc wishes to borrow at a floating rate. Show that:

  1. ABC Corp is better off using a swap with Citigroup than directly borrowing from the market
  2. XYZ Inc is better off using a swap with Citigroup than directly borrowing from the market
  3. Citigroup can take both of these swaps and end up with positive profits on the deals.

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