Consider a plain vanilla interest rate swap. Firm A can borrow at 8% fixed or can borrow floating at LIBOR. Firm B is somewhat less creditworthy and can borrow at 10% fixed or can borrow floating at LIBOR + 1%. Eun wants to borrow floating and Resnick prefers to borrow fixed. Both corporations wish to borrow $10 million for 5 years. Which of the following swaps is mutually beneficial to each party and meets their financing needs?
A)Firm A borrows $10 million externally for 5 years at LIBOR; agrees to swap LIBOR to firm B for 8 ½ % fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at 10%.
B)A borrows $10 million externally for 5 years at LIBOR; agrees to pay 8½% to B for LIBOR fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at 10%.
C)Since the QSD = 0 there is no mutually beneficial swap.
D)A borrows $10 million externally at 8% fixed for 5 years; agrees to swap LIBOR to B for 8½% fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at LIBOR + 1%.

Question

Quizplus · Accepted Answer

- Firm A prefers floating rate and can borrow at LIBOR
- Firm B prefers fixed rate and can borrow at 10%
- To create a mutually beneficial swap, Firm A can borrow at its fixed rate of 8% and swap its floating rate to Firm B for its fixed rate of 8.5%
- Firm B can borrow at LIBOR + 1% and receive a fixed rate of 8.5% from Firm A through the swap
- This swap satisfies both parties' financing needs and creates a win-win situation

Consider a Plain Vanilla Interest Rate Swap