5. Suppose a swap with notional principal of $10 million that exchanges LIBOR for an 8% fixed rate will bring the firm fixed cash inflows of $800,000 per year and obligate it to pay instead ($10 million x LIBOR). a. Show how a firm that has issued a floating rate bond with a coupon equal to the LIBOR rate can use swaps to convert that bond into synthetic fixed rate debt. Assume the terms of the swap allow an exchange of LIBOR for a fixed rate of 8%. b. Firm ABC enters a 5-year swap with firm XYZ to pay LIBOR in return for a fixed 8% rate on notional principal of $10 million. Two year from now, the market rate on 3 year swaps is LIBOR for 7%; at this time firm XYZ goes bankrupt and defaults on its swap obligation. (i) Why is firm ABC harmed by the default? What is the market value of the loss incurred by ABC as a result of the default? Suppose instead that ABC had gone bankrupt. How do you think the swap would be treated in the reorganization of the firm? c. At the present time, one can enter 5 year swap that exchange LIBOR for 8%. An "off market swap" would then be defined as a swap of LIBOR for a fixed rate other than 8%. For example, a firm with 10% coupon debt outstanding might like to convert to synthetic floating rate debt by entering a swap in which it pays LIBOR and receives a fixed rate of 10%. What up-front payment will be required to induce a counterparty to take the other side of this swap? Assume notional principal is $10 million. 5. Suppose a swap with notional principal of $10 million that exchanges LIBOR for an 8% fixed rate will bring the firm fixed cash inflows of $800,000 per year and obligate it to pay instead ($10 million x LIBOR). a. Show how a firm that has issued a floating rate bond with a coupon equal to the LIBOR rate can use swaps to convert that bond into synthetic fixed rate debt. Assume the terms of the swap allow an exchange of LIBOR for a fixed rate of 8%. b. Firm ABC enters a 5-year swap with firm XYZ to pay LIBOR in return for a fixed 8% rate on notional principal of $10 million. Two year from now, the market rate on 3 year swaps is LIBOR for 7%; at this time firm XYZ goes bankrupt and defaults on its swap obligation. (i) Why is firm ABC harmed by the default? What is the market value of the loss incurred by ABC as a result of the default? Suppose instead that ABC had gone bankrupt. How do you think the swap would be treated in the reorganization of the firm? c. At the present time, one can enter 5 year swap that exchange LIBOR for 8%. An "off market swap" would then be defined as a swap of LIBOR for a fixed rate other than 8%. For example, a firm with 10% coupon debt outstanding might like to convert to synthetic floating rate debt by entering a swap in which it pays LIBOR and receives a fixed rate of 10%. What up-front payment will be required to induce a counterparty to take the other side of this swap? Assume notional principal is $10 million