Question

Companies A and B have been offered the following rates per annum on a $20 million 5-year loan, and a bank, acting as intermediary, will charge 0.10% per annum (10 basis points) to arrange and manage the swap, which appears equally attractive to A and B. Fixed Rate Floating Rate Company A 6.0% LIBOR Company B 7.2% LIBOR + 0.50% Company A requires a floating-rate loan, and company B requires a fixed-rate loan. If Company A pays LIBOR to the bank, and the bank pays LIBOR to Company B, what is the net rate that company A will pay? Group of answer choices LIBOR + 0.30% LIBOR - 0.10% LIBOR - 0.30% LIBOR + 0.10%

Answer 1

Total cost if Company A borrows floating and B borrows fixed = LIBOR+7.2%

= LIBOR + 7.2%

Total cost under Swap i.e. when Company A borrows fixed and B borrows floating

= 6% + LIBOR + 0.50%

= LIBOR + 6.5%

Total gain under swap = 0.7%

Charged by Intermediary = 0.10%

Shared by A and B = 0.60%

economic gain of each firm = 0.60%/2 = 0.30%

Net Cost to A = Original cost - Savings under Swap

= LIBOR- 0.30%

Hence, net rate Company A will pay = LIBOR - 30%