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Hi Sir,
Please help with the Swap part, I have tried to do as how you have elaborated in the video lecture but am not getting the effective borrowing rate of 5.04%.
Why is Keshi paying Libor +0.4 , then receiving Libor again? And how comes Keshi pays 4.5% again?
The swap between private companies is straight forward (as learnt from the video), but its difficult when its between a company and a Bank.
Sitting for P4 fourth time this september, wish me luck 🙁
Thanks in advance.
There is more than one way of illustrating it. Here is a different way from the examiners answer – I think his is a bit confusing (even though the final result is obviously correct).
If K borrows fixed at 5.5% and the other borrows floating at L+0.3%, then the total comes to L + 5.8%
If K borrows floating at L+0.4 and the other borrows fixed at L+4.6% then the total comes to L + 5%
So what they should do is the second option and swap i.e. pay each others interest. Between then they will save 0.8% of which K will get 70% which is 0.56% saving.
Without the swap Keshi pays fixed interest of 5.5%.
With the swap they save 0.56% and so end up paying 5.5 – 0.56 = 4.94%. In addition they have to pay 0.1% to the bank which gives a final total of 4.94 + 0.1 = 5.04%.Good luck next week 🙂
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