Xavier Products and Zulu Dawn Construction both seek funding at the lowest possible cost. Xavier prefers the flexibility of floating rate borrowing, while Zulu Dawn wants the security of fixed rate borrowing. Xavier is the more credit-worthy company. They face the following rate structure. Xavier, with the better credit rating, has lower borrowing costs in both types of borrowing. They have agreed to split the comparative advantage 2/3s in favor of Xavier. Xavier wants floating rate debt, so it could borrow at LIBOR+1%. However it could borrow fixed at 8% and swap for floating rate debt. Zulu Dawn wants fixed rate, so it could borrow fixed at 12%. However it could borrow floating at LIBOR+2% and swap for fixed rate debt. How would this swap look (what is the final interest both parties pays)?

If the notional amount barrowed is $10,000,000 and LIBOR rises by .5% what is the cost incurred and who pays this amount to whom? I saw some similar solution but I don't really understand the answer, so I need an answer with clarifications.

Assumptions Xavier Zulu

Credit rating AAA BBB

Prefers to borrow Floating Fixed

Fixed-rate cost of borrowing 8.000% 12.000%

Floating-rate cost of borrowing:

LIBOR (value is unimportant) 5.500% 5.500%

Spread 1.000% 2.000%

Total floating-rate 6.500% 7.500%