7.12. Companies A and B face the following interest rates (adjusted for the difl

ID: 2819821 • Letter: 7

Question

7.12. Companies A and B face the following interest rates (adjusted for the diflerential impact Company A LIBOR + 0.5% of taxes): Company B U.S. dollars (floating rate) Canadian dollars (fixed rate) LIBOR + 1.0% 6.5% 5.0% Assume that A wants to borrow U.S. dollars at a floating rate of interest and B wants to borrow Canadian doliars at a fixed rate of interest. A financial institution is planning to arrange a swap and requires a 50-basis-point spread. If the swap is equally attractive to A and B, what rates of interest will A and B end up paying?

Explanation / Answer

A wants to borrow US$ at floating rate.

B wants to borrow C$ at fixed rate.

Currency

Company A

Company B

Difference (B-A)

US$

LIBOR +0.5%

LIBOR + 1%

0.5%

6.5%

1.5%

As per the table , the borrowing for Company A in Canadian dollars at fixed rate is relatively cheaper than US$.

A will borrow in canadian dollars at fixed rate and B will borrow in US$ at the floating rate.

Total cost of borrowing: LIBOR +1% + 5% + .5% = LIBOR +6.5%

Total cost of borrowing (if borrowed in alternate currency):

LIBOR +0.5% + 6.5% = LIBOR +7%

Total savings = 0.5%

Cost of borrwing

LIBOR +0.5% -0.25% = LIBOR +0.25%

6.5% - 0.25% = 6.25%