Companies A and B face the following interest rates (adjusted for the differenti
ID: 2727653 • Letter: C
Question
Companies A and B face the following interest rates (adjusted for the differential impact of taxes):
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Assume that A wants to borrow US $ at a floating rate and B wants to borrow Can $ at a fixed rate. A financial institution is planning to arrange a swap for a fee of 50 basis points. If the swap is equally attractive to A and B, what rates of interest will A and B end up paying? Diagrammatically present the swap in a figure.
a b US$ Floating LIBOR + 0.5% LIBOR + 1.0% Can$ Fixed 5.0% 6.5%Explanation / Answer
Answer
Particulars
A
B
Gain or (loss)
US$ Floating
LIBOR + 0.5%
LIBOR + 1.0%
-0.50%
Can$ Fixed
5.00%
6.50%
1.50%
Net saving
1.00%
Particulars
Distribution of saving
A financial institution fee
0.50%
A
(1.00%-0.50%)/2
0.25%
B
(1.00%-0.50%)/2
0.25%
Total net savings
1.00%
Financial institution will ask A to borrow Can$ Fixed at 5.00% and Financial institution will offer Can$ Fixed to B at 6.25% (6.50% - 0.25%).
Financial institution will ask B to borrow US$ Floating at LIBOR + 1.0% and Financial institution will offer US$ Floating to A at LIBOR + 0.25% (LIBOR + 0.5% - 0.25%).
Answer : So A will pay LIBOR + 0.25% on US$ Floating and B will pay 6.25% on Can$ Fixed.
Particulars
A
B
Gain or (loss)
US$ Floating
LIBOR + 0.5%
LIBOR + 1.0%
-0.50%
Can$ Fixed
5.00%
6.50%
1.50%
Net saving
1.00%
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