1.Companies X and Y have been offered the following annual interest rates with semi-annual compounding on $5 million 6-year loans.

Company	Fixed Rate (%)	Floating Rate
X	5.00%	LIBOR
Y	7.00%	LIBOR + 1%

Company X borrows initially at a fixed rate but would like to have a floating rate loan. Company Y borrows initially at a floating rate but would like a fixed-rate loan.

a.What is the Quality Spread Differential (QSD)?

b.What is the necessary condition for a fixed-for-floating interest rate swap to be possible?

c.Assuming X and Y split the gains from the swap equally, what are the net borrowing interest rates that X and Y get?

d.Design a swap between the two parties that will net each the same amount of interest rate savings for the types of loans they prefer? (Illustrate with the help of a diagram)

e.If a Financial Intermediary (FI) charges 0.04% a year (split equally between X and Y), how would this affect the final rates that the two parties are paying? (Illustrate with the help of a diagram)

f.What are the net borrowing interest rates that X and Y get after the expenses of the Financial Intermediary is taken into consideration?

2.A company entered into a swap agreement where it pays six-month LIBOR and receives 8% (semi-annual compounding) on a principal of $100 million. The remaining life of the swap is 21 months. The continuously compounded LIBOR rates for 3-months, 9-months, 15-months and 21-months are 10%, 10.5%, 11% and 11.5%. The six months LIBOR on the last payment date was 9.5% (semi-annual compounding). Find the value of the swap to the company.