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3. [8pts] The Star Chemical Company wants to finance one of its production plants by borrowing $150 million for five years. Based on its moderate
3. [8pts] The Star Chemical Company wants to finance one of its production plants by borrowing $150 million for five years. Based on its moderate credit ratings, Star can borrow five-year funds at a 10.5% fixed rate or at a floating rate equal to LIBOR + 75 bp. Given the choice of financing, Star prefers the fixed-rate loan. The Moon Development Company is also looking for five-year funding to finance its proposed $150 million office park development. Given its high credit rating, Moon can borrow the funds for 5 years at a fixed rate of 9.5% or at a floating rate equal to the LIBOR + 25 bp. Given the choice, Moon prefers a variable-rate loan. In summary, Star and Moon have the following fixed and floating rate loan alternatives: Company Fixed Rate 10.5% Star Company Moon Company Floating Rate LIBOR + 75 bp LIBOR + 25 bp 9.5% (1) [2pts] Describe Moon's absolute advantage and each company's comparative advantage? (2) [2pts] What is the total possible interest rate reduction gain for the parties if both were to create synthetic positions with a swap?" (3) [4pts] Suppose the Star and Moon companies both have the same quality ratings with the following fixed and floating rate loan alternatives. What is the total possible interest rate reduction gain for both parties if both parties were to create synthetic positions with a swap? Fixed Rate le Company Star Company Moon Company 9.50% Floating Rate LIBOR + 50 bp LIBOR + 75 bp 9.25%
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