Question

Two companies, ABC and XYZ, are considering entering into a swap. Company ABC can
borrow at a fixed rate of 8.1% or, alternatively LIBOP + 1.3%. Company XYZ faces a fixed rate of
7.5% and a floating rate of LIBOR + 0.3%.
a) Suppose that company ABC wants a floating rate loan, while company XYZ wants a
fixed rate loan. Is there a basis for a swap? If so, set up the swap under the assumption
that interest rate savings is split evenly by the firms.
b) Answer the same question under the assumption that company XYZ wants a floating
rate loan, while company ABC wants a fixed rate loan.

Answer 1

Company	Fixed Rate	Floating rate	Preference
ABC	8.10%	LIBOR+1.3%	Floating
XYZ	7.50%	LIBOR+0.3%	Fixed
Company	Rates received	Rates preferred
ABC	8.10%	LIBOR+1.3%
XYZ	LIBOR+0.3%	7.50%
Total	LIBOR + 8.40%.%	LIBOR + 8.80%
Spread avaialble	(LIBOR + 8.40%)-(LIBOR + 8.80%)
	0.40%
This benefit will be shared equally so 0.20% will be shared.
Effective cost	Preferred Cost	Benefit	Effective cost
ABC	LIBOR+1.3%	-0.20%	LIBOR + 1.10%
XYZ	7.50%	-0.20%	7.30%
Another way
Company	Rates received	Rates preferred
ABC	LIBOR+1.3%	8.10%
XYZ	7.50%	LIBOR+0.3%
Total	LIBOR + 8.80%	LIBOR + 8.40%
Spread avaialble	(LIBOR + 8.40%)-(LIBOR + 8.80%)
	-0.40%
Hence spread is not available in this route