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Dear Sir,
Can you please solve this case study for me . It would be highly appreciable. I have already tried with your style according to your lecture on INTEREST RATE SWAP .
SL has spoken to the bankers who have agreed to provide the $30m needed. Given A company credit rating, the short-term loan will be at a rate of 90 basis points above the LIBOR. Currently, LIBOR is at 6%. The bank has also suggested that, due to current economic uncertainty, LIBOR may rise by 1% or even fall by 0.5% over the coming months.
The bankers have agreed to provide the finance on either at a fixed rate of interest of 8% pa or at a variable rate of LIBOR + 1% pa. The bankers have also informed company A that they have another client, B, who is seeking finance of the same value over the same term. B’s credit rating is not as good as A and they can raise finance at either 11% pa or LIBOR + 2% pa.
Thanks.
I will remember you in my Pray.
You must surely have an answer in the same book in which you found the question?
If you don’t have an answer because you have been set it as an exercise, then I am not going to do it for you 🙂
Type out your answer and I will tell you if I agree 🙂Sorry for that and Yes, I have answere but the problem is I don’t know how they have done it that is the reason I tried with your style but couldn’t do and asked for your help.sorry for inconvenience.
This is from P4 technical articles in ACCA website. The article name is INTEREST RISK MANAGEMENT.
If A borrows floating themselves they will be paying L + 1%; If B borrows fixed themselves then they will be paying 11%. So in total they will be paying L + 1 + 11 = L + 12%.
Instead A should borrow fixed and B should borrow floating, and then they swap and pay each others interest.
So A ends up paying B’s interest of L + 2%, and B ends up paying A’s interest of 8%. (So a total of L + 10%, which is a saving of 2%. However the bank is charging a fee of 1% which reduces the saving to 1%, and A and B will share the saving between them so they will both save 0.5% on what they would have been paying if there had been no swap.
With no swap A would have borrowed floating at L + 1%, and so the end result of swapping (and saving 0.5%) would be that they end up paying L + 0.5%
With no swap B would have borrowed fixed at 11%, and so the end result of swapping (and saving 0.5%) will be that then end up paying 10.5%.
(It will mean a transfer between them to arrange the net result, but this is irrelevant for the exam (and can be done in various ways, although the net transfer remains the same)- it is the end result that matters.)
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