Question
Marine Knife Limited (MK) and Ocean Clear Corporation (OC) would like to raise funds to expand their operation. With their respective business characteristics, MK targets
Marine Knife Limited (MK) and Ocean Clear Corporation (OC) would like to raise funds to expand their operation. With their respective business characteristics, MK targets a floating-rate loan while OC looks for a fixed-rate borrowing. MK is a new company without a strong credit history. The firm is required to borrow funds by paying 8.5% p.a. for fixed rate borrowing or LIBOR + 6.0% p.a. for floating rate loans. OC, however, is a well- established firm with excellent credit record. The company can borrow money either at 7% p.a. fixed rate or at LIBOR +1.50% p.a. floating rate in the credit market.
a. What is the interest rate difference in borrowing fixed rate loans between the two companies? What is the difference in borrowing floating rate loans? Explain which company has a comparative advantage in fixed rate loans and which company has a comparative advantage in floating rate loans.
b. Suppose you are the relationship manager of Open Bank and the two companies are your customers. Design a swap structure that will allow both Marine Knife Limited and Ocean Clear Corporation to be benefited equally, while at the same time allowing your bank as an intermediary to profit 0.60% (60 basis points) p.a. from it. (12 marks)
c. If Marine Knife Limited agreed to engage in the swap contract you have proposed, evaluate the net borrowing cost to the firm. Compare this net borrowing cost with direct borrowing in the credit market, how many basis points of interest rate can the company save from the swap contract?
d. Is a multiple-year swap effectively a series of forward contracts? Explain briefly.
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