(15) Why do companies face the need to swap their liabilities? Explain the role
ID: 2799507 • Letter: #
Question
(15) Why do companies face the need to swap their liabilities? Explain the role of swap brokers in the context of markets. What are some rates which serve as variable rate indexes and how are the swap rates quoted? Cit example(s) (15) 4. PART B Answer all questions 5. Alpha and Beta Companies can borrow for a five-year term at the following rates: Moody's credit rating Fixed-rate borrowing cost Floating-rate borrowing cost Alpha Aa 12.0% LIBOR Beta Baa 14.5% LIBOR + 1% a. Calculate the quality spread differential (QSD). b. Develop an interest rate swap in which a swap bank, Alpha and Beta share the savings equally if any Assume Alpha desires floating-rate debt and Beta desires fixed-rate debt. (15) 6. A five-year, 5 percent Euro-yen bond sells at par. A comparable risk currency bond pays $940 at maturity. It sells for ¥110 000 par value of the bond i, ¥100 000 (10) ar, 5.5 percent yen/dollar dual- what is the implied Y $ exchange rate at maturity? Hint: TheExplanation / Answer
If Alpha and Beta were to take the loans of their choice with their credit ratings, the total interest expenditure would come up to:
Alpha-floating = LIBOR
Beta-fixed = 14.5%
Total = LIBOR + 14.5%
Instead, if they were to take up the opposite and enter into a swap agreement, the interest payments made to their banks would be:
Alpha-fixed = 12%
Beta-floating = LIBOR + 1%
Total = LIBOR + 13%
By entering into a swap agreement, they would end up saving 1.5% which is the quality spread differential.
The swap can be arranged like this:
For Alpha
Alpha pays bank = 12%
Alpha pays Beta = LIBOR
Alpha receives from Beta = 12.75%
Total interest liability for Alpha = LIBOR - 0.75%
Floating offered by bank = LIBOR
Saving made = 0.75%
For Beta
Beta pays bank = LIBOR + 1%
Beta pays Alpha = 12.75%
Beta receives from Alpha = LIBOR
Total interest liability for Beta = 13.75%
Fixed offered by bank = 14.5%
Saving made = 0.75%
This way, both Alpha and Beta come off with better interest rates of their choice and the quality spread differential of 1.5% has been distributed equally, i.e. 0.75% for each party.
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