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Homework answers / question archive / Companies A and B have been offered the following rates per annum on a $100 million five-year loan: Fixed rate Floating rate Company A 4
Companies A and B have been offered the following rates per annum on a $100 million five-year loan:
|
Fixed rate |
Floating rate |
|
|
Company A |
4.0% |
LIBOR + 0.2% |
|
Company B |
5.2% |
LIBOR + 0.8% |
Company A requires a floating-rate loan; company B requires a fixed-rate loan.
Answer:
A will be surely better off and will have competitive advantage if it borrows at fixed rate and B would have a competitive advantage if it borrows at floating rate. The difference between fixed rate and floating rates are:
Difference between fixed rate = 5.20%-4% =1.20%
Difference between floating rate = LIBOR + 0.8% - (LIBOR +0.20%)
= 0.60%
The total gain to both the parties if they swap would be 1.20%-0.60% = 0.60%. Since company A is getting the floating rate loan at LIBOR +0.2%
the SWAP should be able to make both companies better off by (0.60%-0.20%)/2 = 0.20%.
That means
Company A should be borrowing at LIBOR +0.40%
Company B should be borrowing at 5%.
