Company A and B can borrow $40 million for a 3-year term at the following rates. While A desires fixed-rate borrowing, B prefers floating-rate borrowing.
Fixed-Rate
Floating-Rate
A
8.5%
LIBOR+0.5%
B
7%
LIBOR
The swap bank currently makes a market for plain vanilla 3-year interest rate swaps at 7.25% - 7.50%.
QUESTIONS (There are toally 4 questions):
(1) Illustrate how Company A benefits from the use of interest rate swap.
(2) Summarize the risks taken by the swap bank in the interest swap with Company B.
(3) Suppose the swap bank does not customize interest rate swaps. Is it possible for Company B to get a cost saving of 0.35% from the use of quoted swaps? Explain.
(4) Suppose both Company A and B entered into the 3-year swaps with the swap bank. One year after the inception of the 3-year swaps, the swap bank quotes 2-year interest rate swaps at 6.5-7%. Which company is willing to unwind the original swap? Explain. How much it is willing to pay to unwind?
Company A and B can borrow $40 million for a 3-year term at the following rates. While A desires fixed-rate borrowing, B prefers floating-rate borrowing.
| Fixed-Rate | Floating-Rate | |
| A | 8.5% | LIBOR+0.5% |
| B | 7% | LIBOR |
The swap bank currently makes a market for plain vanilla 3-year interest rate swaps at 7.25% - 7.50%.
QUESTIONS (There are toally 4 questions):
(1) Illustrate how Company A benefits from the use of interest rate swap.
(2) Summarize the risks taken by the swap bank in the interest swap with Company B.
(3) Suppose the swap bank does not customize interest rate swaps. Is it possible for Company B to get a cost saving of 0.35% from the use of quoted swaps? Explain.
(4) Suppose both Company A and B entered into the 3-year swaps with the swap bank. One year after the inception of the 3-year swaps, the swap bank quotes 2-year interest rate swaps at 6.5-7%. Which company is willing to unwind the original swap? Explain. How much it is willing to pay to unwind?
Related questions
Alpha and Beta Companies can borrow for a five-year term at the following rates:
| Alpha | Beta | |
| Moodyâs credit rating | Aa | Baa |
| Fixed-rate borrowing cost | 10.5% | 12.0% |
| Floating-rate borrowing cost | LIBOR | LIBOR + 1% |
QUESTIONS: 2 questions
(1) Calculate the quality spread differential (QSD).
(2) Develop an interest rate swap on behalf of the swap bank, in which the swap bank will earn a
profit of 10 basis points. In addition, Alpha and Beta would have equal cost savings by doing the
swap. Assume Alpha desires floating-rate debt and Beta desires fixed-rate debt.
