Question

1. Company A, a low-rated firm, desires a fixed-rate, long-term loan. A currently has access to floating interest rate funds at a margin of 0.5% over LIBOR. Its direct borrowing cost is 13% in the fixed-rate bond market. In contrast, company B, which prefers a floating-rate loan, has access to fixed-rate funds in the Eurodollar bond market at 11% and floating rate funds al LIBOR + 1.5% How can A and B use a swap to advantage?

Answer 1

As we can see that Company A has cheaper access to floataing rate loan that means at Libor +0.5 % margin but requires fixed rated loan which is expensive

Whereas Company B has access to cheaper fixed rated loan that means at 11% but requires floating rated loan which is expensive

Therefore,in this situation if both the companies enter into swapping than it will be advantageous for both.

Now let's understand how it will be beneficial:-

Company A will take floating rate loan from market and then give this loan to company B and company B will take fixed rated loan from market and give this loan to Company A .

Now in this way ,Company A will have desired fixed rated loan at 11% .So advantage of 13-11=2%

And Company B will have desired floating rated bond at Libor+0.5% margin .So advantage =Libor+1.5-(Libor+0.5%)

=1%