Question
Company ABC and XYZ have been offered the following rates on a five-year loan: Company Fixed Rate Floating Rate Company ABC 9.4% LIBOR +0.1%
Company ABC and XYZ have been offered the following rates on a five-year loan: Company Fixed Rate Floating Rate Company ABC 9.4% LIBOR +0.1% Company XYZ 9.6% LIBOR +0.7% Company ABC requires a fixed-rate loan; Company XYZ requires a floating-rate loan. (i) Design a swap that will net a bank, acting as intermediary, 0.1% and that will appear equally attractive to both companies. (ii) The swap constructed in (i) is sometimes considered as a one-way arbitrage as both ABC and XYZ are able to exploit their comparative advantage to reduce their borrowing costs. Is this really an arbitrage in the sense that the saving is obtained without the parties taking on extra risk?
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