1. One of the reasons why the interest rate swaps are used and popular is the be
ID: 2725440 • Letter: 1
Question
1. One of the reasons why the interest rate swaps are used and popular is the benefit of comparative advantage in the type of loans between fixed and floating loans. Suppose that the fixed and floating rates available for American Airlines (AAL) and Exxon mobile (XOM) for ten-year loans are as shown in the following table.
XOM
AAL
Fixed rate
3.6%
8.0%
Floating rate
LIBOR + 250 bp
LIBOR + 950 bp
How much of interest is saved for both companies by the comparative advantage argument in the swap trading?
2. One of the reasons why the interest rate swaps are used and popular is the benefit of comparative advantage in the type of loans between fixed and floating loans. Suppose that the fixed and floating rates available for American Airlines (AAL) and Exxon mobile (XOM) for ten-year loans are as shown in the following table.
XOM
AAL
Fixed rate
3.6%
8.0%
Floating rate
LIBOR + 250 bp
LIBOR + 950 bp
Which of the following is true?
XOM
AAL
Fixed rate
3.6%
8.0%
Floating rate
LIBOR + 250 bp
LIBOR + 950 bp
Explanation / Answer
2. XOM and AAL have the comparative advantages in fixed rate and floating rate, respectively.
Reason: XOM has a fixed rate to floating rate ratio of higher than AAL. So, XOM has an absolute advantage in both but comparative advantage in Fixed rate only while AAL has an absolute disadvantage in both but comparative advantage in Floating rate.
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