Question

Two companies have investments which pay the following rates of interest:

	Fixed	Float
Firm A	6%	Libor
Firm B	8%	Libor+0.5%

Assume A prefers a fixed rate and B prefers a floating rate. Show how these two firms can both benefit by entering into a swap agreement. If an intermediary charges both parties equally a 0.1% fee and any benefits are spread equally between Firm A and Firm B, then

1) what rates could A and B receive on their preferred interest rate? (1 mark)

2) Please draw the cash flow chart. (1 mark)

Part 1 Answer in the form of below:

	Fixed	Floating
Firm A
Firm B
Difference
Total gain to all the three parties (A, B and the intermediary)
Total gain to A and B

Part 2 in the form of:

Cash Flows of A	Cash Flows of B
Receives _____ from the outside borrowers	Receives _____ from outside borrowers
Pays ______ to the intermediary	Pay____ to the intermediary
Receives _____ from the intermediary	Receives ______ from the intermediary
Net effect: receives	Net effect: receives

Cash Flows of the intermediary

Receives _____ from Firm A

Pays _____ to Firm A

Receives ____ from Firm B

Pays _____ to Firm B

Receives: __________= 0.1%

Answer 1