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Reunert, a company listed in the industrial goods and services sector of the Johannesburg Stock Exchange (JSE) is considering entering into an interest rate swap
Reunert, a company listed in the industrial goods and services sector of the Johannesburg Stock Exchange (JSE) is considering entering into an interest rate swap agreement with Shoprite, a quality food retailer. Both companies want to finance their expansion with a loan of R100 million for 5 years. Reunert wants to finance an interest-rate-sensitive asset and, therefore, wants to borrow at a floating rate. Shoprite wants to finance an interest-rate-insensitive asset and, thus, wants to borrow at a fixed rate. Reunert can borrow at a fixed rate of 10% or at a floating rate of JIBAR. Shoprite can borrow at a fixed rate of 12% or at a floating rate of JIBAR +0.5%. The swap dealer charges a commission of 0.50% with bid-ask quotes of 10.50%11.00%. Required: 1.1. Determine whether there is a swap opportunity for the companies by calculating the quality spread differential (QSD). (5 marks) 1.2. Tabulate the net cash flow for each company and determine the net saving for each company. (11 marks) 1.3. Discuss two reasons why a company would enter into a swap agreement. (4 marks)
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