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John thank you for your quick response to my posts. I now i have another problem. it concerns interest rate swaps. suppose party A has an AAA credit rating and can borrow at fixed rate of 5% and a variable rate of LIBOR +1%. Party B has a BB credit rating and can borrow at fixed rate 7% or variable of LIBOR + 3%, they want to go into a swap agreement
will it be beneficial if A borrow fixed or variable and what will be the advantage to both parties. excuse me if my question is not well formulated. I think i came across a similar question in one past paper and how it was answered i did not understand
thank youYou must ask in the Ask the Tutor Forum if you want me to answer!!
If A borrows fixed and B borrows floating, then in total they will pay 5% + (L + 3%) = L + 8%
If B borrows fixed and A borrows floating, then in total they will pay 7% + (L + 1%) = L + 8%
So there is nothing to be gained by swapping.
thank you but i think i asked the question wrongly. i will look for the question and ask again there is a past question where they will gain by swapping
You take the same approach as above. In exams the two totals are not the same and the difference is the gain to be made.
i just posted an extract of the june 2014 question in the ask the tutor forum. if i follow the approach you gave above
CMC borrows fixed and counter party variable they will pay in total 2.2 + yield rate + 0.8 = 3% and CMC borrows variable and counter party borrows fixed they will pay 3.8 +0.4 = 4,2%
net gain for both parties = 4.2- 3 = 1.2% and if shared equally each will gain 1.2% if i am correct. how can i proceed from here
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