The Cookie Creme Company (Party A) prefers to have fixed rate debt, but has a higher fixed rate of 5% annually, while its variable cost of debt is LIBOR + 1%, with LIBOR at this time at 3%. The Bright Window Company (Party B) would prefer to have variable rate debt, but its fixed rate for debt is 4% annually is lower than its variable rate debt of LIBOR + 1.50% (with LIBOR at this time at 3%).
The two parties agree to a 10-year swap for a given amount at a brokerage fee cost of 0.10% for each party for a given notational amount.
• Party A will continue to issue variable rate debt that costs LIBOR + 1% (currently 3%), and Party B will continue to issue fixed rate debt that costs 4%.
Swap of Partial payments:
• Party A will pay Party B cash flows based on the notational amount at a fixed rate of 4%.
• Party B will pay Party A cash flows based at a rate equal to LIBOR + 1% (Libor currently 4%)
a. What are the liability swap rates (effective rates on debt) that each party will in net be paying on their debt with this swap?
(Hint: liability swap rate = dr % - pi% + po% + fee%) where dr is the firm's rate on the type of debt it is using; po% is the rate to be paid to the other party; pi is the rate to be received from the other party; and fee% is the brokerage rate for the swap.)
b. Given your answers in a., what is the financing advantage for each party?

Question

The Cookie Creme Company (Party A) prefers to have fixed rate debt, but has a higher fixed rate of 5% annually, while its variable cost of debt is LIBOR + 1%, with LIBOR at this time at 3%. The Bright Window Company (Party B) would prefer to have variable rate debt, but its fixed rate for debt is 4% annually is lower than its variable rate debt of LIBOR + 1.50% (with LIBOR at this time at 3%).
The two parties agree to a 10-year swap for a given amount at a brokerage fee cost of 0.10% for each party for a given notational amount.
• Party A will continue to issue variable rate debt that costs LIBOR + 1% (currently 3%), and Party B will continue to issue fixed rate debt that costs 4%.
Swap of Partial payments:
• Party A will pay Party B cash flows based on the notational amount at a fixed rate of 4%.
• Party B will pay Party A cash flows based at a rate equal to LIBOR + 1% (Libor currently 4%)
a. What are the liability swap rates (effective rates on debt) that each party will in net be paying on their debt with this swap? 
(Hint: liability swap rate = dr % - pi% + po% + fee%) where dr is the firm's rate on the type of debt it is using; po% is the rate to be paid to the other party; pi is the rate to be received from the other party; and fee% is the brokerage rate for the swap.)
b. Given your answers in a., what is the financing advantage for each party?

Quizplus · Accepted Answer

The Answer of The Cookie Creme Company (Party A) prefers to have fixed rate debt, but has a higher fixed rate of 5% annually, while its variable cost of debt is LIBOR + 1%, with LIBOR at this time at 3%. The Bright Window Company (Party B) would prefer to have variable rate debt, but its fixed rate for debt is 4% annually is lower than its variable rate debt of LIBOR + 1.50% (with LIBOR at this time at 3%).
The two parties agree to a 10-year swap for a given amount at a brokerage fee cost of 0.10% for each party for a given notational amount.
• Party A will continue to issue variable rate debt that costs LIBOR + 1% (currently 3%), and Party B will continue to issue fixed rate debt that costs 4%.
Swap of Partial payments:
• Party A will pay Party B cash flows based on the notational amount at a fixed rate of 4%.
• Party B will pay Party A cash flows based at a rate equal to LIBOR + 1% (Libor currently 4%)
a. What are the liability swap rates (effective rates on debt) that each party will in net be paying on their debt with this swap? 
(Hint: liability swap rate = dr % - pi% + po% + fee%) where dr is the firm's rate on the type of debt it is using; po% is the rate to be paid to the other party; pi is the rate to be received from the other party; and fee% is the brokerage rate for the swap.)
b. Given your answers in a., what is the financing advantage for each party?

The Cookie Creme Company (Party A) Prefers to Have Fixed