1.Consider two hypothetical companies, A and B. Company A is a top-rated AAA company, whereas company B is a lower-rated BBB company. Assume that company A wants to raise debt and pays a floating interest rate, which is usually done to finance short-term receivables and credit that earns a short-term interest rate. Company B, conversely, wants long-term fixed rate financing, perhaps to finance the purchase of machinery and equipment. The cost to each party of accessing either the fixed-rate or the floating-rate market for a new five-year debt issue is as follows:

A)Is it possible for the two companies to reduce their financing costs through interest rate swaps? Why or why not?

B)If your answer to A) is yes, help the companies to arrange a swap contract such that both companies have the same amount of interest savings. What is the risk associated with the swap arrangement?