Companies A and B have been offered the following interest rates per annum on a 10 million 3-year loan:

	Fixed Rate	Floating Rate
Company A	5.4%	LIBOR
Company B	7.0%	LIBOR+0.2%

Company A requires a floating-rate loan; company B requires a fixed-rate loan. All interest rates in the table are reported with annual compounding. Consider a swap in which fixed and floating payments are exchanged every year.

Discuss the contractual agreement between the parties in a plain vanilla interest rate swap. Explain why the borrowing rates reported in the table provide the basis for an interest rate swap. Design a swap that will net a bank, acting as an intermediary, 20 basis points per annum, and will appear equally attractive to both companies. Show your calculations and use a diagram to illustrate how the swap with the financial institution can be arranged.