Question 1.

Alpha and Beta Companies can borrow for a five-year term at the following rates:

	Alpha	Beta
Moody's credit rating	Aa	Baa
Fixed-rate borrowing cost	10.5%	12.0%
Floating-rate borrowing cost	LIBOR	LIBOR + 1%

a. Calculate the quality spread differential (QSD)

b. Develop an interest rate swap in which both Alpha and Beta have an equal cost savings in their borrowing costs. Assume Alpha desires floating-rate debt and Beta desires fixed-rate debt. No swap bank is involved in this transaction.

Question 2.

Do Question 1 over again, this time assuming more realistically that a swap bank is involved as an intermediary. Assume the swap bank is quoting five-year dollar interest rate swaps at 10.7-10.8 percent against LIBOR flat.

You want to explain how the firms use the swap step by step.