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Companies X and Y have been offered the following rates per annum on a $5 million 10-year investment:
|
Fixed Rate |
Floating Rate |
|
|
Company X |
8.0% |
LIBOR |
|
Company Y |
8.8% |
LIBOR |
Company X requires a fixed-rate investment; Company Y requires a floating-rate investment. Design a swap that will net a bank, acting as intermediary, 0.2% per annum and will appear equally attractive to X and Y.
Answer:
Total return if Company X invests at Fixed rate and Y borrows at floating rate = 8% + LIBOR = LIBOR + 8%
total return if X invests at floating rate and Y invests at fixed rate under swap = LIBOR + 8.8% = LIBOR + 8.8%
Gain under swap = 0.8%
Intermediary = 0.2%
Shared by each company = 0.6%/2 = 0.3%
Effective return will be
X = 8%+0.3% = 8.3%
Y = LIBOR + 0.3% = LIBOR + 0.3%
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