A and B companies have been offered the following rates per annum on a 1 million

Question

A and B companies have been offered the following rates per annum on a 1 million dollars of investment. Company A fixed rate of 4.86% and floating rate (in percent) LIBOR+0.5, company B fixed rate of 6.12 and floating rate(in percent) LIBOR+0.6. Company A requires a fixed rate investment and company B requires a floating rate investment. Design a swap that will net a bank acting as a financial intermediary (F.I.) 30 percent of the benefits and be equally attractive to both the companies. Draw a complete picture to show the exact transactions and check that the F.I., X, and Y are better off in your swap deal by receiving benefits exactly as asked. Find the following in your swap scheme with all numerical values: a)Benefit of swap in dollar per year. b)Return on B’s investment in capital markets in dollar per year c)Receipt by F.I. from B in dollar per year. d)Receipt by A from F.I. in dollar per year

Explanation / Answer

Own Choice of the companies A Required fixed rate investment B Required floating rate investment Swap Agreement Company A will invest fund at LIBOR+-.5% and enter swap agreement with swap dealer to receive fixed rate and pay floating rate Company will invest fund at fixed rate 6.12% and enter swap agreement with swap dealer to receive floating rate and pay fixed   rate Effective rate of investment of two companies A   Total rate under            4.86% - LIBOR+0.6% =   -LIBOR + 4.26% Total rate under SWAP Agreement          6.12% - LIBOR+0.5% =   -LIBOR + 5.62% Net Benefit under Swap Ageement (-LIBOR+5.62% - (-LIBOR+ 4.26%)   =   1.36% Benefit for both companies is Equal For A ==      1.36/2 =     0.68 For B ==      1.36/2 =     0.68 Net Benefit for Companises For A ==      1.36/2 =     0.68- .30 for bank intermedairy =   0.38 a Benefit of swap in dollar per year =       $ 1 million * 1.36%   = $ 13600 b Return on B investment in capital market Assume LIBOR = 5% Net Rate   5%+ 0.6%+ 0.38% = 5.98% 1 million * 5.98%   = $ 59800 per year c receipt by FI from B 1 Million * 0.30 =   $ 3000 d receipt by FI from A 1 Million * 0.30 =   $ 3000

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