Q2. Interest Rate Swap Companies A and B both plan to borrow $15 million for 5-years. The companies face different borrowing costs. Company A can borrow for a fixed rate of 9% per annum or a floating rate of LIBOR+1% per annum. Company B can borrow for a fixed rate of 11% per annum or a floating rate of LIBOR+2% per annum. Suppose company A prefers floating rate, company B prefers fixed rate, and they sign a swap agreement. Company A borrows $15m for 5 years at 9.00% fixed rate, company B borrows $15m for 5 years at LIBOR+2% floating rate, and A agrees to pay B a floating rate LIBOR+1% to swap for a fixed rate 9.50% from B. Prove that the swap agreement would benefit both companies, comparing to the situation without swap when A borrows at floating rate and B borrows at fixed rate. Fixed Rate Floating Rate (preferred) Company A 9.00% LIBOR + 1% A LIBOR+1 9.5 Fixed Rate (preferred) Floating Rate Company B 11.00% LIBOR + 2% Answer: Company B Pay bank: The payoffs are as follows: Company A Pay bank: Pay B: Receive from B: Total: Pay A: Receive from A: Total: Comparing to the situation wihtout swap, both company A and B gain 0.5% in interest cost. Q2. Interest Rate Swap Companies A and B both plan to borrow $15 million for 5-years. The companies face different borrowing costs. Company A can borrow for a fixed rate of 9% per annum or a floating rate of LIBOR+1% per annum. Company B can borrow for a fixed rate of 11% per annum or a floating rate of LIBOR+2% per annum. Suppose company A prefers floating rate, company B prefers fixed rate, and they sign a swap agreement. Company A borrows $15m for 5 years at 9.00% fixed rate, company B borrows $15m for 5 years at LIBOR+2% floating rate, and A agrees to pay B a floating rate LIBOR+1% to swap for a fixed rate 9.50% from B. Prove that the swap agreement would benefit both companies, comparing to the situation without swap when A borrows at floating rate and B borrows at fixed rate. Fixed Rate Floating Rate (preferred) Company A 9.00% LIBOR + 1% A LIBOR+1 9.5 Fixed Rate (preferred) Floating Rate Company B 11.00% LIBOR + 2% Answer: Company B Pay bank: The payoffs are as follows: Company A Pay bank: Pay B: Receive from B: Total: Pay A: Receive from A: Total: Comparing to the situation wihtout swap, both company A and B gain 0.5% in interest cost