Dear sir or madam,

I hope you are well. I am working currently on an exercise on interest SWAPS and am a bit stuck. I'd appreciate your knowledge.

This is the question:

Two companies have investments which pay the following rates of interest:

Fixed

Float

Firm A

6%

Libor

Firm B

8%

Libor+0.5%

Assume A prefers a fixed rate and B prefers a floating rate. Show how these two firms can both benefit by entering into a swap agreement. If an intermediary charges both parties equally a 0.1% fee and any benefits are spread equally between Firm A and Firm B, what rates could A and B receive on their preferred interest rate?

This is my answer so far:

The basis of the swap is the comparative advantage that Firm A has with their fixed rate and Firm B with the floating rate. Even though Firm A has the comparative advantage on the fixed rate they still may want to borrow on floating conditions, same for Firm B, they may comparative advantage on the floating rate but would prefer a fixed rate.

Step I: The Difference between Firm A and Firm B's Rates

Fixed -Firm A 8% - Firm B 6% = 2%

Float -Firm A LIBOR - Firm B LIBOR +0.5% = 0.5%

Step II: Calculate Costs

Intermediary cost charged both equally - 2 x 0.10% = 0.20%

Step III: Calculate the Spread in bp

Difference in Fixed Rates200bp

Less: Difference in Float Rates (50bp)

Less: Intermediary Costs (20bp)

Total Spread130bp

Step IV: Distribute Spread evenly

Total Spread 130bp / 2 = 65 bp each

Firm A = Fixed 600bp + 65 bp spread = 665 bp (6.65%)

Firm B = Float (LIBOR + 50bp) + 65 bp spread = LIBOR + 115 bp (LIBOR +1.15%)

My question is:

How do I draw it?