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Firms A and B wish to secure loans from the domestic market. The credit conditions for each firm are determined by the cost of borrowing,
Firms A and B wish to secure loans from the domestic market. The credit conditions for each firm are determined by the cost of borrowing, either through fixed or floating-rate loans: Firm A has the option to secure a fixed-rate loan from the market at 9.5% or a floating-rate loan at LIBOR + 180 basis points (bps). Firm B can obtain a fixed-rate loan directly from the market at 9.8% or a floating-rate loan at LIBOR + 200 bps. Firm A intends to borrow at a floating rate. However, instead of borrowing directly at LIBOR + 180 bps, they choose to secure a fixed-rate loan from the market and subsequently enter into a swap contract with Bank XYZ. The swap conditions for Firm A are as follows: they will pay LIBOR + 160 bps and receive 9.4%. Firm B, on the other hand, prefers a fixed-rate loan. Yet rather than securing one directly at 9.8%, they decide to borrow at a floating rate from the market and then enter into a swap contract with Bank XYZ The swap conditions for Firm B are as follows: they will pay 9.5% and receive LIBOR + 180 bps. a) Please indicate the position on the IRS contract for firms A and B. b) Draw a diagram with the cost of financing with the market and the cost of financing for firms A and B through swap contracts with bank XYZ. c) What is the final borrowing cost for Firm A after entering into the swap contract? Please indicate if the final cost is fixed or floating. Then, indicate the cost savings by comparing the cost of borrowing using the swaps versus the cost of borrowing directly in the market. d) What is the final borrowing cost for Firm B after entering into the swap contract? Please indicate if the final cost is fixed or floating. Then, indicate the cost savings by comparing the cost of borrowing using the swaps versus the cost of borrowing directly in the market. e) What is the benefit (if any) for Bank XYZ
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