Firm A and Firm B are considering an interest rate swap. Firm A can borrow fixed

Question

Firm A and Firm B are considering an interest rate swap. Firm A can borrow fixed at 7% or at Libor plus 100BP. Firm B can Borrow fixed at 8% or at Libor plus 250BP.

6. Which is statement is true?
a. Firm B has the absolute advantage
b. Firm A has the comparative advantage in Fixed Rates
c. You can save the firms a total of 50BP if they swap
d. You can save the firms a total of 150BP if they swap
e. Firm B can save 150 BP if it swaps

7. If the firms swap, which of the following must be true?
a. Firm A will wind up paying Fixed
b. Firm B will wind up paying Fixed
c. Firm A will pay floating to B
d. Firm A will save 25BP
e. None of the above

8. If firm A agrees to pay 8% fixed to B, then what is the minimum payment that firm A is willing to receive from B?

a. 7% plus 50BP
b. Libor minus 100
c. Libor plus 100
d. Libor plus 200
e. Libor minus 200

Please can you explain how you get the answers. Would be really helpful.

Explanation / Answer

Remember a BP or Basis Point is 0.01 of 1% or 0.01%. "LIBOR is the interest rate that banks charge each other for one-month, three-month, six-month and one-year loans." thanks to About dot com 6. Which is statement is true? b. Firm A has the comparative advantage in Fixed Rates They rates are much lower for the consumer. 7. If the firms swap, which of the following must be true? e. None of the above No proof of fixed rates, they always fluctuate. 8. If firm A agrees to pay 8% fixed to B, then what is the minimum payment that firm A is willing to receive from B? b. Libor minus 100 equaling 7% minimum. I hope this helped, best of luck.

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