Lluvia Manufacturing and Paraguas Products both seek funding at the lowest possible cost. Lluvia would prefer the flexibility of floating rate borrowing, while Paraguas wants the security of fixed rate borrowing. Lluvia is the more credit-worthy company. They face the following rate structure. Lluvia, with the better credit rating, has lower borrowing costs in both types of borrowing.

Lluvia wants floating rate debt, so it could borrow at LIBOR+1.75%. However, it could borrow fixed at 10% and swap for floating rate debt. Paraguas wants fixed rate, so it could borrow fixed at 14.25%. However, it could borrow floating at LIBOR+3% and swap for fixed rate debt. The swap bank is involved in this transaction and gain 0.5%. The rest is shared by the two counterparties. What should they do?

Lluvia Paraguas

Fixed-rate borrowing cost 10% 14.25%

Floating-rate borrowing cost LIBOR+1.75% LIBOR + 3%

o Apha Beta Fixed 10.5% 12% LIBOR +1) Floting UBOR . 127-10.5% = 1.5% 1,57.-17.20.5% } 2 LIBOR +1% - Libor 0.1% 0.2.0.2 Swap Alpha Bank ( 10.77 - Swap Books UBOR 13.87. UBOR I Alpha Beta. t boroued freed. losy. Bete LIBOR 127. Alpha -OST. - TIBOR +10.77 borrowed floating UBOR +1% Beta -LIBOR 1 TLIBOR -10.8%. - 11.81 -LIBOR +0.2% - 11.8% 0.27. 0.2% LIBOR +0.2%