Two companies in chemical industry are P and Q. The high quality borrower (P) prefers to raise $50 million in five years floating rate funding. The low quality company (Q) prefers to raise $50 million in five years fixed rate funding. This is explained in table presented below.

Type of borrowers	Fix	Float
Coy P	5%	L-0.50%*
Coy Q	7%*	L+0.50%

Required

1. A)Explaininwhichratedoes(P)and(Q)hascomparativeadvantage.WhatisthestrategytocreateaswapcontractbetweenPandQ?Whatarethegainsfromswap?(5marks)

1. B)
2. LetX=totalbasispoint.ShowthatnetcashoutflowtoPisL-2%+XandQis7.50%-X.Suppose.49%and.51%thenexplainhowthenetcashoutflowofeachpartiessatisfytheoverallgainfromswapof1%underthetwoXvalues.(3marks).

C)

1. A range of values is possible for X that satisfies the Pareto-improvement condition. For example If X = 1.0% explain the net cost to each parties and show that your results matches gains from swap in part (a). (4 marks)