Question

Companies X and Y have been offered the following rates per annum on a $5 million 10-year investment, and a bank, acting as intermediary, will charge 0.2% per annum (20 basis points) to arrange and manage the swap, which appear equally attractive to X and Y. Please note that this is an investment swap, not a liability swap, so the arrows move in the opposite direction as the examples in the module. Please see the Hull textbook for more details. Fixed Rate Floating Rate Company X 8.0% LIBOR Company Y 8.8% LIBOR Company X requires a fixed-rate investment, and company Y requires a floating-rate investment. If Company X pays LIBOR to the bank, and the bank pays LIBOR to Company Y, what is the net rate that Company Y will receive on its investment? Group of answer choices LIBOR LIBOR + 0.3% LIBOR + 0.1% LIBOR + 0.2%

Answer 1

Total return if Company X invests at fixed rate and Y borrows at floating rate = 8% + LIBOR Total return if X invests at floating rate and Y invests at fixed rate under swap = LBOR + 8.8% Gain under swap = 0.8% Intermediary = 0.2% Shared by each company = 0.6%/2 = 0.3% Effective return will be X = 8%+0.3% = 8.3% Y = LIBOR + 0.3%