Question

Suppose firm Alpha can borrow either at 6% or Libor + 1% and firm Beta borrow either at 8% or Libor + 2%. Assume that there is a swap bank who is willing to distribute any benefit by keeping 1/5th to itself, and 2/5th each to Alpha and Beta. Which of the following is false based on the above information?

Alpha is going to receive 5.8% from the swap bank for Libor.

Beta’s borrowing net borrowing rate is 7.6% after the swap arrangement.

Beta is going to pay 5.6% to the swap bank for Libor.

Alpha is going to borrow at 6% at the capital market.

Answer 1

Answer: Option (1) Alpha is going to receive 5.8% from the swap bank for Libor.

Alternatives Posssible:

I: Aplha Choosing Variable rate Loan and Beta choosing Fixed rate Loan.

II: Aplha Choosing Fixed rate Loan and Beta choosing Variable rate Loan.

-	Fixed	Variable	Alternative I	Alternative II
Alpha	6%	LIBOR + 1%	LIBOR + 1%	6%
Beta	8%	LIBOR + 2%	8%	LIBOR + 2%
Total Cost	-	-	LIBOR + 9%	LIBOR + 8%

Benefit is possibe if Alternative II is choosed instead of Alternative I.

Benefit = (LIBOR + 9%) - (LIBOR + 8%)

Benefit = 1%

Benefit Sharing:

1/5th to Swap Bank = 0.2%

2/5th to Alpha = 0.4%

2/5th to Beta = 0.4%

	Before Cost	Swap Execution	Net Cost After Swap	Payment to Swap Bank	Reciept from Swap Bank
Alpha	LIBOR + 1%	6%	LIBOR + 0.6%	LIBOR	5.40%
Beta	8%	LIBOR + 2%	7.60%	5.60%	LIBOR

Beta is going to pay 5.6% to the swap bank for Libor.

Alpha is going to borrow at 6% at the capital market

Beta’s borrowing net borrowing rate is 7.6% after the swap arrangement.

Alpha is going to receive 5.4% from the swap bank for Libor but not 5.8%.