Question 1 [30 marks]

(a) Explain the term interest rate swap and highlight the rationale underpinning it. [10 marks]

(b) Discuss how a FX swap is different from a currency swap. [5 marks]

(c) What are the preconditions for an interest rate swap to take place? [5 marks]

(d) Omega and Theta Companies can borrow for a five-year term at the following rates:

Omega and Theta has S&Ps credit rating AAA BBB, Fixed-rate borrowing cost 10.5% 12.0%, Floating-rate borrowing cost LIBOR LIBOR + 1% respectively. A swap bank is involved as an intermediary and is quoting five-year dollar interest rate swaps at 10.7% - 10.8% against LIBOR flat. Propose an interest rate swap in which both companies benefit equally. [10 marks]