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Question 1. a. Companies A and B have been offered the following rates per annum on a $20 million five-year loan: Fixed Rate Floating Rate
Question 1. a. Companies A and B have been offered the following rates per annum on a $20 million five-year loan: Fixed Rate Floating Rate Company A 5.0% LIBOR+0.1% Company B 6.4% LIBOR+0.6% Company A requires a floating-rate loan and company B requires a fixed-rate loan. Design a swap that will net a bank, acting as intermediary, 0.1% per annum and that will appear equally attractive to both companies. b. A $100 million interest rate swap has a remaining life of 10 months. Under the terms of the swap, six-month LIBOR is exchanged for 7% per annum (compounded semi-annually). The average of the bid-offer rate being exchanged for six-month LIBOR in swaps of all maturities is currently 5% per annum with continuous compounding. The six-month LIBOR rate was 4.6% per annum two months ago. What is the current value of the swap to the party paying floating? What is the value of the swap to the party paying fixed? (10 marks) C. Critically evaluate why a European option is always cheaper than an American option on the same asset with the same strike price and exercise date. Support your answer with examples. Use no more than 400 words. d. Using no more than 400 words, explain carefully the following derivative instruments: Credit default swaps. Collateral debt obligations
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