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Company AAA and Company BBB are both seek funding at the lowest possible cost. They face the following rate structures: Company AAA Company BBB Cost
Company AAA and Company BBB are both seek funding at the lowest possible cost. They face the following rate structures:
| Company AAA | Company BBB |
Cost of fixed-rate borrowing | 10.00% | 13.00% |
Cost of floating-rate borrowing | LIBOR+0.50% | LIBOR+1.00% |
- In what type of borrowing does Company AAA have a comparative advantage? Why?
- In what type of borrowing does Company BBB have a comparative advantage? Why?
- If an interest rate swap were arranged between the two firms, what would be the maximum savings?
- Briefly explain why interest rate swaps are used. Why are they useful?
- Illustrate an interest rate swap that would generate savings divided equally between the two firms.
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