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In: Finance

Company A can borrow fixed at 14.8 percent and floating at LIBOR percent. Company B can...

Company A can borrow fixed at 14.8 percent and floating at LIBOR percent. Company B can borrow fixed at 16.2 percent and floating at LIBOR+ 0.35 percent. A financial intermediary charges a fee of 0.14 percent. Company A wishes to borrow floating and company B wishes to borrow fixed. Assume the gain is evenly split between the two parties and floating rate legs are LIBOR. Design the swap. What is the company A's fixed rate leg and company B's fixed rate leg, respectively.

Solutions

Expert Solution

Company A wishes to borrow floating and company B wishes to borrow fixed

In the normal scenario the total interest rate for both the companies will be

LIBOR for company A + 16.2 % for company B

In case company A borrows fixed and company B borrows floating then total interest rate will be

14.8% + LIBOR + .35% = 15.15% + LIBOR

Fees of finance intermediary = .14% (assuming, this is total fees from both the parties)

Net gain from transaction = (16.2% + LIBOR) - (15.15% + LIBOR) - .14% = .91%

Net benefit to each company = .91/2 = .455%

SWAP

Company A will Pay (LIBOR - .455%) to company B and will receive 14.8% from company B

and its total expense will be LIBOR - .455% with the benefit of .455% from swap

Company B will pay 14.8% to company A and.14% to intermediary as fee and LIBOR +.35 for loan

and will receive (LIBOR - .455%) from company A

And total expense will be (14.8 + .455 + .35 + .14)% = 15.745% with the benefit of .455% from (16.2-.15.745)% from Swap

Summary

1 2 3 4 5 6 = 2+4+5-3
Company Intention Pay for loan Receive Pay Fees Net pay
A LIBOR 14.8 14.8 LIBOR - .455% LIBOR - .455%
B 16.2 LIBOR + .35 LIBOR-.455% 14.80% 0.14% 15.745%

Assumption: Total fee of .14% is charged from both companies and not .14% from each company.

jeff jeffy answered 2 hours ago
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