1. 8.

Interest Rate Swaps [LO 23.3] ABC Company and XYZ Company need to raise funds to pay for capital improvements at their manufacturing plants. ABC Company is a well-established firm with an excellent credit rating in the debt market; it can borrow funds either at an 11 per cent fixed rate or at 30-day Bank Bill rate + 1 per cent floating rate. XYZ Company is a fledgling startup firm without a strong credit history. It can borrow funds either at a 10 per cent fixed rate or at 30-day Bank Bill rate + 3 per cent floating rate.

1. Is there an opportunity here for ABC and XYZ to benefit by means of an interest rate swap?

2. Suppose you have just been hired at a bank that acts as a dealer in the swaps market, and your boss has shown you the borrowing rate information for your clients ABC and XYZ. Describe how you could bring these two companies together in an interest rate swap that would make both firms better off while netting your bank a 2.0 per cent profit.