Question 1 Netflix and Hulu both seek funding at the lowest possible cost. Netfl

Question

Question 1 Netflix and Hulu both seek funding at the lowest possible cost. Netflix would prefer the flexibility of floating rate borrowing, while Hulu wants the security of fixed rate borrowing. Assume that Netflix is the more credit-worthy company. They face the following rate structure. Netflix, with the better credit rating, has lower borrowing costs in both types of borrowing. Fixed-Rate Available Floating-Rate Available Borrower Hulu Netflix 10% 6% LIBOR + 2% LIBOR + 1% I a. What is the difference in fixed-rate available between Hulu Products and Netflix Manufacturing? b. What is the difference in floating-rate available between Hulu Products and Netflix Manufacturing? c. What is the spread differential between fixed-rate and floating-rate available? d. Show the interest rate swap transactions between Hulu Products and Netfix if they agree to equally share the savings from the spread differential.

Explanation / Answer

a) Difference in fixed rate = 10% - 6% = 4% b) Difference in floating rate = (LIBOR+2)-(LIBOR+1) = 1% C) Spread available = 4%-1% = 3%. d) Equal share in the spread would be 1.5% each. HULU NETFLIX Borrow at -(LIBOR+2) -6% Hulu to Net flix -7.50% +7.5% Netflix to Hulu +(LIBOR+1) -(LIBOR+1) Net rate throught SWAP -8.5% -(LIBOR-0.5) Rate for direct borrowing 10% LIBOR+1% Gain 1.50% 1.50% e) HULU NETFLIX Borrow at -(LIBOR+2) -6% Hulu to Net flix -8.00% +8.0% Netflix to Hulu +(LIBOR+1) -(LIBOR+1) Net rate throught SWAP -9.0% -(LIBOR-1.0) Rate for direct borrowing 10% LIBOR+1% Gain 1.00% 2.00%

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