2 Companies A and B face the following interest rates: Company A 3% Company B x% UK pounds (fixed rate) US dollars (floating rate) LIBOR-0.25% LIBOR-0.5% (i) Assuming that A wants to borrow in British pounds at a fixed rate and B wants to borrow in US dollars at a floating rate, derive a lower or upper bound for x that allows these companies to enter into a profitable swap agreement. (ii) Assume now that x = 2.5%, design a swap that is equally at- tractive to both companies arranged by a financial intermediary that makes a profit of 0.05% from these operations. (iii) Assume now that x = 2.8%, describe the conditions under which a swap contract between A and B makes sense. Design a swap that is equally attractive to both companies without a financial intermediary.

2 Companies A and B face the following interest rates: Company A 3% Company B x% UK pounds (fixed rate) US dollars (floating rate) LIBOR-0.25% LIBOR-0.5% (i) Assuming that A wants to borrow in British pounds at a fixed rate and B wants to borrow in US dollars at a floating rate, derive a lower or upper bound for x that allows these companies to enter into a profitable swap agreement. (ii) Assume now that x = 2.5%, design a swap that is equally at- tractive to both companies arranged by a financial intermediary that makes a profit of 0.05% from these operations. (iii) Assume now that x = 2.8%, describe the conditions under which a swap contract between A and B makes sense. Design a swap that is equally attractive to both companies without a financial intermediary.

International Financial Management

14th Edition

ISBN:9780357130698

Author:Madura

Publisher:Madura

Chapter8: Relationships Among Inflation, Interest Rates, And Exchange Rates

Section: Chapter Questions

Problem 33QA

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Two companies, Company A and Company B, are looking to enter into an interest rate swap agreement. Company A Company B Fixed rate 5% 6% Floating Rate 3-month LIBOR plus 1% 3-month LIBOR plus 1.5% Suppose that company A requires a floating-rate borrowing and company B requires a fixed- rating borrowing. A financial institution is planning to arrange a swap and requires 20bps spread. If benefits are equally shared both companies, what rate of interest will A and B pay?
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