JP Morgan needs to borrow $5 million to finance an R&D project. To avoid the interest rate risk, a fixed rate loan is preferable. However, fixed rate loan is not available in the U.S. for JP Morgan because of market frictions. Mercedes-Benz needs to borrow $5 million to finance a floating rate Eurodollar loan to its client. To avoid the interest rate risk, floating rate note is preferable. However, floating rate loan is not available in Germany for Mercedes because of market frictions. If fairly priced, JP Morgan can borrow at the fixed interest rate of 6% or at the floating rate of LIBOR. Mercedes-Benz can borrow at a fixed rate of 4.4% or at the floating rate of LIBOR-0.4%. A swap bank is used as an intermediary for the deal. The swap bank and the two counterparts of the deal agree that they are going to equally split the total gains from the swap deal. (30 points)

(1) Compute the quality spread differential (QSD). (4 points)

(2) If Mercedes agrees to pay LIBOR-0.4% flat to the swap bank, what interest rate should Mercedes receive from the swap bank? (5 points)

(3) If JP Morgan agrees to pay 4.8% fixed rate to the swap bank, what interest rate should JP Morgan receive from the swap bank? (5 points)

(4) Draw the flow chart showing all the interest rate payments and receipts for the three parties involved in the swap deal. (12 points)

(5) Also compute and show net interest payment for each of the counterparts and the swap bank. (4 points)