A Company and B Company need to raise funds to pay for capital improvements at t

Question

A Company and B Company need to raise funds to pay for capital improvements at their manufacturing plants. A Company is a well-established firm with an excellent credit rating in the debt market; it can borrow funds either at 11 percent fixed rate or at LIBOR + 1 percent floating rate. B Company is a fledgling start-up firm without a strong credit history. It can borrow funds either at 10 percent fixed rate or LIBOR + 3 percent floating rate.

a. If the amount each firm wants to borrow is 100,000,000 payable back in 3 years, can you describe how would you attempt to price the swap for the floating-rate payer firm?

b. What other information you would need for pricing the swap?

Explanation / Answer

A company B company Fixed rate 11 10 Floating rate LIBOR + 1 LIBOR + 3 Desired borrowing LIBOR + 1 10 Actual borrowing 11 LIBOR + 3 Swap LIBOR + 3 11 Gain/loss 2 1 Gain adjustment -0.5 0.5 Gain 1.5 1.5 Borrowing 9.5% LIBOR + 1.5%

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