ACCA AFM · Guided practice (Show me how)
Chapter 21: Interest Rate Risk Management (2)
Interest rate swaps: sharing a comparative advantage
L is the bank's reference rate for floating-rate borrowing (the notes: LIBOR).
(a) Company X can borrow fixed at 10% or floating at L + 3%. Company Y can borrow fixed at 12% or floating at L + 6.5%. X wants fixed-rate debt and Y wants floating-rate debt. They borrow equal amounts.
(b) Company A can borrow fixed at 10% or floating at L + 1%. Company B can borrow fixed at 11% or floating at L + 1.5%. L is currently 9%. A's income fluctuates with interest rates; B's does not. They borrow equal amounts and share the saving equally.
(a) Is there a gain to share?
Calculate the total costs of the two borrowing routes and the gain available from a swap.
(b) Design the swap
Identify the borrowing arrangement and calculate the total saving, each company's net cost and the extra payment from B to A.
Opening this exercise…