Interest Rate Swap Question 1 Assume that the following information is relevant

Question

Interest Rate Swap

Question 1

Assume that the following information is relevant to a one year interest rate swap:

Initiation Date

12/16/07

Direct Issue Fixed rate cost to A rated

4.5%

Direct Issue Floating rate cost to A rated

LIBOR + 55

Notional Principal

$10 million

Direct Issue Floating rate cost to B-rated

LIBOR + 80BPs

Direct Issue Fixed rate cost to B-rated

5.25%

1 year on the run Treas. Rate

3.75%

Determine the potential savings that could be exploited using an interest rate swap.

Assuming a swap is structured as follows:

4.75% vs. LIBOR + 55

Calculate the All-in-cost for both counterparties to the swap

Using market convention, restate the swap as a fixed rate spread over the Treasury vs. LIBOR flat, assuming a 5BP bid/ask spread

Initiation Date

12/16/07

Direct Issue Fixed rate cost to A rated

4.5%

Direct Issue Floating rate cost to A rated

LIBOR + 55

Notional Principal

$10 million

Direct Issue Floating rate cost to B-rated

LIBOR + 80BPs

Direct Issue Fixed rate cost to B-rated

5.25%

1 year on the run Treas. Rate

3.75%

Explanation / Answer

Answer

Answer 1

Determine the potential savings that could be exploited using an interest rate swap.

Particulars

A Rated

B Rated

Difference

Fixed

4.50%

5.25%

0.75%

Floating

LIBOR+55

LIBOR+80

-0.25%

Saving

0.50%

Particulars

A Rated

B Rated

Difference

Fixed

4.50%

5.25%

0.75%

Floating

LIBOR+55

LIBOR+80

-0.25%

Saving

0.50%

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