What is a swap? Suppose two firms have different credit ratings. Firm Hi can borrow fixed at 11% and floating at LIBOR + 1%. Firm Lo can borrow fixed at 11.4% and floating at LIBOR + 1.5%. Describe a floating versus fixed interest rate swap between firms Hi and Lo in which Lo also makes a side payment of 45 basis points to Firm L.

It is January, and Tennessee Sunshine is considering issuing $5 million in bonds in June to raise capital for an expansion. Currently, the firm can issue 20-year bonds with a 7% coupon (with interest paid semiannually), but interest rates are on the rise and Stooksbury is concerned that long-term interest rates might rise by as much as 1% before June. You looked online and found that June T-bond futures are trading at 111250. What are the risks of not hedging, and how might TS hedge this exposure? In your analysis, consider what would happen if interest rates all increased by 1%.