18h 3 (13 marks) Diamond Inc. and Rainbow Inc. both seek funding at the lowest possible cost. Diamond would prefer the flexibility of floating rate borrowing while Rainbow wants the security of fixed rate borrowing. Diamond is the more credit-worthy company and, with the better credit rating, has lower financing costs in both debt markets. They each face the following rate structure: Diamond Rainbow Floating interest LIBOR +0.5% LIBOR +1.5% Fixed interest 5% 7% Diamond wants floating rate debt - it could borrow from the floating market directly or borrow at the fixed rate and swap for floating rate debt. On the other hand, Rainbow wants fixed rate debt- it could borrow at the fixed rate directly or borrow floating and swap for fixed rate debt. Required: a) Describe and calculate the funding cost advantage enjoyed by Diamond, which represents the opportunity set for improvement in funding costs to be distributed between both parties. (1 mark) b) Based on your analysis in part a), please suggest the type of funds (fixed or floating) for Diamond and Rainbow. (1 mark) d) Using the savings as a result of Diamond's funding cost advantage and assuming that both firms share the savings equally, design a swap arrangement between Diamond and Rainbow that meets their preferences for interest rate payments and also results in a lower funding cost for both companies. (6 marks) Assume that the notional value of the swap arrangement is $100 million, the maturity of the agreement is 4 years, and the current LIBOR rate is 4.8% p.a. In a table, show the net swap payments in each year and which party makes a payment, if the fixed-rate is 5% in the swap contract and the LIBOR rate over the next 4 years is 4.9%, 5.0%, 5.3% and 5.5%. (5 marks)