Question
Companies Alpha and Beta are currently both based in Chicago. They are both contemplation expanding their business by taking a $14 million loan which will
Companies Alpha and Beta are currently both based in Chicago. They are both contemplation expanding their business by taking a $14 million loan which will be spread over ten years. Company Alpha requires a floating-rate loan; company B requires a fixed-rate loan.
| Fixed Rate | Floating Rate | |
Alpha | 4.20% | LIBOR+ | 0.2% |
Beta | 5.20% | LIBOR+ | 0.7% |
(a) Which company has a comparative advantage in a fixed loan, and which company has a comparative advantage in a floating loan? Explain your answer.
(b) If a swap arrangement is made, Alpha would be borrowing at the fixed or floating rates? Explain your answer.
(c) If Standard Chartered Bank, acts as a financial intermediary, seeking 0.3% per annum as their charges, what will be the net benefit from the swap deal, assuming the swap deal equally attractive to both Alpha and Beta?
(d) How much commission Chartered Bank would be making in 1 year?
(e) Construct a swap deal, showing clearly all the transactions involved. Demonstrate that both parties are better off with the swap.
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