Probio Ltd, an Australian biomedical firm, wishes to borrow US dollars at a floating rate of interest while Shale Inc

Answer:

Swap: Swap is a derivative contract. Interest rate swaps is a contract between two parties where both the paries agreed to exchange a series of cash flow on a pre agreed amount.

Here Probio wants to borrow in USD at floating rate and Shale Inc wants to borrow in AUD in fixed rate. And here dealer want 20 basis point as a fee.

100 basis point = 1%

Here Shale Inc has advantage in borrowing rates but Probio has comparative advantage in fixed rate because the difference is lower compare to floating rate.

Now the net advantage will be for both party is,

= (USD LIBOR + 3% - USD LIBOR - 1.5 ) - 7.5% - 6.8%

= 0.8%

Now from these 0.2% will go to dealer

So net advantage of 0.6% will be equally shared by both parties in swap agreement. So the net borrow cost will be decrease by 0.3% for both party.

Here we will say to Probio to go and borrow in Fixed rate and Say to Shale to go and borrow in floating rate.

And then Probio will pay LIBOR +1.6% to dealer under swap agreement and Shale will pay 6.5% under swap agreement. And from both dealer will charge 0.1%.

Now here both the party will have 0.3% benefit in borrowing,

Let's look,

For Probio the net interest cost is,

= 7.5 (Market AUD borrowing) + LIBOR + 1.6% (payment under swap) - 6.4% (receives under swap)

= USD LIBOR + 2.7%

So Probio gets loan in USD at floating rate and 0.3% less cost.

Now for Shale

= LIBOR + 1.5 (Market USD borrowing) + 6.5% (payment under swap) - LIBOR - 1.5% (receives under swap)

= 6.5%

So Shale gets loan in AUD at fixed rate and 0.3% cost less.

So here Shale Inc. would pay AUD 6.5% fixed to dealer.

Let look swap design:

Please see the attached file