Question
Company CC3, a low-rated firm, desires a floating-rate, long-term loan. CC3 presently has access to floating interest rates finds at a margin of 5.5% over
Company CC3, a low-rated firm, desires a floating-rate, long-term loan. CC3 presently has access to floating interest rates finds at a margin of 5.5% over LIBOR. Its direct borrowing cost is 14% in the fixed-rate bond market. In contrast, company AA1, which prefers a fixed-rate loan, has access to fixed-rate funds in the Eurodollar bond market at 12% and floating-rate funds at LIBOR + 0.5%.
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(a) What is the size of the mispricing (if any)?
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(b) Design a swap acceptable to both companies. Split the benefits evenly between the two
companies. Diagram the cash flows of the two companies and clearly indicate the swap rates that the two companies are using (c) What is the final borrowing rate for each company?
(Loan amount is not required in this question)
Please show all workings.
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