Question

Two firms X and Y are able to borrow funds as follows:

Firm A: Fixed-rate funding at 3.5% and floating rate at Libor-1%.

Firm B: Fixed-rate funding at 4.5% and floating rate at Libor+2%.

Assume A prefers fixed rate and B prefers floating rate. Show how these two firms can both obtain cheaper financing using a swap. What swap strategy would you suggest to the two firms if you were an unbiased advisor? What is the net cost to each party in the swap? Show your work in detail.

Answer 1

Total cost without swap
Firm A	Fixed rate =	3.50%
Firm B	Floating rate =	Libor + 2%
Total cost =		Libor + 5.50%
If Firm A borrow Floating and Firm B borrow Fixed and exchange or make swap, then cost is
Firm A	Floating rate =	Libor - 1%
Firm B	Fixed rate =	4.50%
Total cost =		Libor +4.40%
Total swap gain = Cost without swap - cost with swap
Libor + 5.50% - (Libor +4.40%)
1.10%
Gain will be divided equally. 1.1%/2 = 0.55%
Net cost to Firm A = Cost without swap - gain
3.50%-0.55%
2.95%
Net cost to firm B = Cost without Swap - gain
Libor +2% - 0.55%
Libor +1.45%

I being an unbiased advisor suggest Firm A to take Floating rate loan and Firm B to Take fixed rate loan and share the gain equally.
Then Net cost to Firm A =	2.95%
Net cost to firm B=	Libor +1.45%