1. Two firms, Astor Corporation and Beluga Fish Packing Inc., are seeking financing in the fixed rate and floating rate debt markets. Given the rates at which they can borrow in these markets and their preferences, they sense an opportunity to reduce their borrowing costs by entering into a swap agreement and have decided to contact a swap bank/dealer.

Astor Corporation can borrow at a floating rate of LIBOR + 1% or at a fixed rate of 12%. Beluga Fish Packing Inc. can borrow at a floating rate of LIBOR + 2% or at a fixed rate of 15%. Assume that Astor prefers to borrow at a floating rate and Beluga prefers to borrow at a fixed rate.

You are the swap bank. Compute the quality spread differential (QSD) or the cost savings opportunity in these rates that makes a swap contract attractive. Structure an interest rate swap agreement that benefits both parties equally, reducing their borrowing costs (versus what it would otherwise be) and allows you to receive a fee of 1%. Show separately how you arrive at the net borrowing costs of Astor Corporation and Beluga Fish Packing Inc.