ABC Company and XYZ Company need to raise funds to pay for capital improvements

Question

ABC Company and XYZ Company need to raise funds to pay for capital improvements at their manufacturing plants. ABC Company is a well-established firm with an excellent credit rating in the debt market; it can borrow funds either at 11 percent fixed rate or at LIBOR + 1 percent floating rate. XYZ Company is a fledgling start-up firm without a strong credit history. It can borrow funds either at 10 percent fixed rate or LIBOR + 3 percent floating rate.

If the amount each firm wants to borrow is 100m payable back in 3 years, can you describe how would you attempt to price the swap for the floating-rate payer firm? What other information you would need for that?

Explanation / Answer

ABC company XYZ company Fixed rate 11 10 Floating rate LIBOR + 1 LIBOR + 3 Desired borrowing LIBOR + 1 10 Actual borrowing 11 LIBOR + 3 Swap LIBOR + 3 11 Gain/loss 2 1 Gain adjustment -0.5 0.5 Gain 1.5 1.5 Borrowing 9.5% LIBOR + 1.5%

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