Question 3 (20 marks) JPMorgen is a large investment bank that provides funding services for clients across the world. Gauging the funding demand from clients, they identify swap opportunities that could potentially lower their clients' borrowing costs. Two clients Safety and Risky approach the firm with their following requests. Risky prefers to borrow in the variable-rate market, as its main revenues are sensitive to interest rate changes. On the other hand, most of Safety's incomes in the next few years are locked. As a result, Safety's preference is to borrow in the fixed-rate market. Safety can borrow in the fixed- and variable-rate markets at 15% and LIBOR + 4%, respectively. Risky can borrow in the fixed and variable markets at 13% and LIBOR + 3%, respectively. JPMorgen proposes an interest-rate swap deal in which they advise the two parties to swap payments. Risky is particularly unimpressed with the proposal and argues that the swap will only benefit Safety, as Safety faces higher borrowing costs than Risky in both markets. A) Explain to Risky why they might benefit from the swap. Make sure that your explanation includes the potential savings from the interest rate swap deal? (8 marks) B) Show both clients that the interest rate swap will work with the following assumptions: 1) Risky will have 60% of the potential savings, and Safety will receive 30% of the potential savings 2) JPMorgen will receive the rest of the savings. Note that you can have multiple correct answers. Your answer will need to detail all of the necessary transactions in the swap. (12 marks) Question 3 (20 marks) JPMorgen is a large investment bank that provides funding services for clients across the world. Gauging the funding demand from clients, they identify swap opportunities that could potentially lower their clients' borrowing costs. Two clients Safety and Risky approach the firm with their following requests. Risky prefers to borrow in the variable-rate market, as its main revenues are sensitive to interest rate changes. On the other hand, most of Safety's incomes in the next few years are locked. As a result, Safety's preference is to borrow in the fixed-rate market. Safety can borrow in the fixed- and variable-rate markets at 15% and LIBOR + 4%, respectively. Risky can borrow in the fixed and variable markets at 13% and LIBOR + 3%, respectively. JPMorgen proposes an interest-rate swap deal in which they advise the two parties to swap payments. Risky is particularly unimpressed with the proposal and argues that the swap will only benefit Safety, as Safety faces higher borrowing costs than Risky in both markets. A) Explain to Risky why they might benefit from the swap. Make sure that your explanation includes the potential savings from the interest rate swap deal? (8 marks) B) Show both clients that the interest rate swap will work with the following assumptions: 1) Risky will have 60% of the potential savings, and Safety will receive 30% of the potential savings 2) JPMorgen will receive the rest of the savings. Note that you can have multiple correct answers. Your answer will need to detail all of the necessary transactions in the swap. (12 marks)