Bosie Ltd is about to establish a new funding arrangement.It is able to borrow in either the fixed-rate or floating-rate debt markets.The company wishes to lower its cost of borrowing by entering into a swap transaction with Matlock Ltd.Based on the following data for the two companies,in which interest rate market will Matlock Ltd borrow,and swap into?
$$\begin{array} { | l | l | }
\hline \text { Bosie Ltd } & \text { fixed rate } 10.8 \% \text { per annum; floating rate BBSW } + 0.3 \% \text { per annum } \
\hline \text { Matlock Ltd } & \text { fixed rate } 11.5 \% \text { per annum; floating rate BBSW } + 0.7 \% \text { per annum } \
\hline
\end{array}$$

Question

Bosie Ltd is about to establish a new funding arrangement.It is able to borrow in either the fixed-rate or floating-rate debt markets.The company wishes to lower its cost of borrowing by entering into a swap transaction with Matlock Ltd.Based on the following data for the two companies,in which interest rate market will Matlock Ltd borrow,and swap into?
$$\begin{array} { | l | l | } 
\hline \text { Bosie Ltd } & \text { fixed rate } 10.8 \% \text { per annum; floating rate BBSW } + 0.3 \% \text { per annum } \
\hline \text { Matlock Ltd } & \text { fixed rate } 11.5 \% \text { per annum; floating rate BBSW } + 0.7 \% \text { per annum } \
\hline
\end{array}$$

Quizplus · Accepted Answer

In a swap transaction, each party should borrow in the market where it has a comparative advantage. Matlock Ltd has a smaller comparative disadvantage in the fixed rate market (11.5% vs. 10.8% for Bosie Ltd, a difference of 0.7%) than in the floating rate market (BBSW + 0.7% vs. BBSW + 0.3% for Bosie Ltd, a difference of 0.4%). Therefore, Matlock Ltd should borrow at the fixed interest rate and swap into the floating rate to minimize its cost of borrowing.

Bosie Ltd Is About to Establish a New Funding Arrangement