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Interserve and Kier Group can borrow for one year at the following rates: Interserve 4.50% Kier Group 5.10% LIBOR + 0.15% LIBOR +0.35% Fixed

Interserve and Kier Group can borrow for one year at the following rates: Interserve 4.50% Kier Group 5.10% LIBOR + 0.15% LIBOR +0.35% Fixed rate Floating rate Calculate the quality spread differential for each rate and determine each company's comparative advantage. What does it imply for the borrowing costs of the two companies? [20 marks] Develop an interest rate swap in which both companies have an equal saving in their borrowing costs. Assume Interserve desires floating-rate debt and Kier desires fixed-rate debt and that the intermediary swap bank demands a 0.1% fee on the transaction. [30 marks] b) What does a convex tax code imply? How does a company benefit from hedging if it faces a convex tax code? If the corporate tax rate is flat, would a firm benefit from hedging? i. ii. [30 marks] c) Why does an increase in the (historic) volatility of foreign exchange rates increase the value of foreign currency options? [20 marks]

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