IRS Suppose Company X is an international company and its client is requesting a 10-year $5,000,000 floating-rate loan. Company Y needs $5,000,000 to finance a 10-year project. X is an AAA-rated bank and Y is a BBB-rated company. Based on the nature of the cash flows, X should borrow floating and Y should borrow fixed. Their external borrowing costs are shown below:
fixed rate borrowing cost floating rate borrowing cost
company x 10% LIBOR
company y 12% LIBOR +1.5%
A swap bank is quoting bid-ask at 10.05-10.45% against 6-month LIBOR. Answer the following questions.
(1) Based on their borrowing costs, state which company has the comparative advantage in borrowing fixed and which has the comparative advantage in borrowing floating? Why?
(2) Based on your answer in (1), perform a fixed-for-floating interest rate swap for X and Y through a swap bank. Write in the values (interest rates) for A, B, C, D, E, and F on the diagram
(3) Calculate the savings in the borrowing costs (interest rates) for X and Y with the interest rate swap.
(4) Calculate the profit of the swap bank in the interest rate swap D=