Two companies with the borrowing rates below are considering a swap agreement.
______________________________Floating rate_________________ Fixed rate
Company A..............................LIBOR.......................................12%
Company B...............................LIBOR + 0.3%....................................13.5%
Company A needs a floating rate loan of £5m and Company B a fixed rate loan of £5m.
(a) Which company has a comparative advantage in floating rate debt and which company has a comparative advantage in fixed rate debt?
(b) At what rate will Company A be able to obtain floating rate debt and Company B be able to obtain fixed rate debt, if the two companies agree a swap and the benefits of the swap are split equally between them? Ignore bank charges.