Question

Financial Derivatives (FIN429) Tuesday 07-May-2019 QUESTION # 10 Max. Marks 10-4+2+2+2] o. prefers to borrow at fl Co. and Cocoa Co. want to borrow USD 150 million for 10 years. Monoca at Hoating rate of interest, while Cocoa Co. has a preference to borrow at interest. Suppose that National Bank offers the followings to Monoca Co. and Cocoa Companies Quotes Fixed LIBOR-1% | 85% Monoca Co. | LIBOR+ 1.5% 9.5% Floating F cocoa Co. | aronl b hee e 1. Construct the interest rate swaps involving a swap dealer, Cocoa Co, Monoca Co. and National Bank, where Swap Bank as swap dealer would get 60 basis points. nt 2. Compute net payments for Cocoa Co., Monoca Co. and the Swap Bank resulting from the swap contract. ard ANSWER di

Answer 1

1)		CC has absolute advantage in Floating rate of L+1.5% - L-1% =			2.50%
		MC has comparative advantage in Fixed rate = 9.5%-8.5% =			1.00%
		Advantage from swap			1.50%
		Fee to the Swap Bank			0.60%
		Net advantage to A & B			0.90%
		To be shared equally by CC 65 basis points and MC 25 basis points
		[Sharing in the ratio of 2.5:1]
			8.50%		L+1.5%
	L-1%	Cocoa Co	---------------------->	Swap Bank	<---------------------	Monoca Co	9.50%
	<-------------------						----------------------->
			<-----------------------		--------------------->
			L-0.35%		9.75%
2)		Net rate to CC = -(L-1%)-8.50%+(L-0.35%) = 7.85%			Gain for CC = 8.50%-7.85% = 0.65%
		Net rate to MC = -9.50%+9.75%-(L+1.5%) = L+1.25%			Gain for MC = (L+1.5%)-(L+1.25%) = 0.25%