10. Interest Rate Swaps capital improvements at their manufacturing plants. ABC
ID: 2799743 • Letter: 1
Question
10. Interest Rate Swaps capital improvements at their manufacturing plants. ABC Company is a firm with an excellent credit rating in the debt market; it can borrow funds either 11 percent fixed rate or at LIBOR +1 percent floating rate. XYZ Company is a f start-up firm without a strong credit history. It can borrow funds either at 10 percent fixed rate or at LIBOR+3 percent floating rate. ABC Company and XYZ Compan y need to raise funds to pay for well-established at XYZ to benefit by means of an interest rate swap? b. Suppose you've just been hired at a bank that acts as a dealer in the swaps mar- ket, and your boss has shown you the borrowing rate information for your clients, ABC and XYZ. Describe how you could bring these two companies together in an interest rate swap that would make both firms better off while netting your bank a 2 percent profit.Explanation / Answer
a) XYZ has comparative advantage relative to ABC in borrowing at fixed interest rates, while ABC has comparative advantage relative to XYZ in borrowing at floating interest rates. There is an opportunity of 3% gain by entering into interest rate swap
b) Table showing benefits of swap
Particulars ABC XYZ Gain Fixed 11% 10% 1% Floating Libor+1% Libor+3% 2% Loan ABC will take floating rate loan XYZ will take fixed loan Net gain 3% Less: bank commission 2% Gain to be distributed to companies 1%Related Questions
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