. Lehman Company and Strait Enterprises need to raise funds to pay for capital improvements at their manufacturing plants. Lehman Company can borrow funds either at 5.5 percent fixed rate or at LIBOR + 1.5. Strait Enterprises can borrow funds either at 5 percent fixed rate or at LIBOR + 0.5. Assume that Lehman borrows at a fixed rate and Strait borrows at a floating rate. The two companies enter into a swap whereby Strait pays 5.5% to Lehman and Lehman pays LIBOR + 1.25% to Strait.

a. What are the net payments for Lehman and Strait if they engage in the swap?

b. Will Lehman be better off (or worse off) to issue fixed-rate debt or to issue floating-rate debt and engage in the swap? How much?

c. Will Strait be better off (or worse off) to issue floating-rate debt or to issue fixed-rate debt and engage in the swap? How much?