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Good morning John, i have come with an extract of the June 2014 question oneb on interest rate swap. this is an area that i dont really understand what is happening even after going through the solution i don’t understand it below is an extract
CMC will take a four-year CHF60,000,000 to part-fund the setting up of four branches. Interest will be payable on the loan at a fixed annual rate of 2·2% or a floating annual rate based on the yield curve rate plus 0·40%. The loan’s principal amount will be repayable in full at the end of the fourth year.
Pecunia Bank is willing to offer an interest rate swap contract with a counterparty, where the counterparty can borrow at an annual floating rate
based on the yield curve rate plus 0·8% or an annual fixed rate of 3·8%. Pecunia Bank would charge a fee of 20 basis points each to act as the intermediary of the swap. Both parties will benefit equally from the swap
contract.
Required
Demonstrate how CMC Co could benefit from the swap offered by Pecunia Bank.
the solution talks of comparative advantage, the net result figure. i don’t seem to understand what is going on. please i need help in this area
thank youHave you tried doing what I did in my previous answer to you?!
You do exactly the same here.If CMC borrows floating and other borrows fixed, then the total is (L + 0.4%) + 3.8% = L + 4.2%
If CMC borrows fixed and the other floating, then the total is 2.2% + (L + 0.8%) = L + 3%
So by swapping they can same a total of 1.2% before bank fees. The bank charges 2 x 0.2 = 0.4%, so there is still; a net saving to be made.
yes John i did try it in the other forum. so if i get you well, by swapping they will save 1.2% and if i then deduct the bank charges of 0.4%, the net gain is 1.2%-0.4% = 0.8% . this will give a net gain to each party of 0.4% since they gain equally. am i right?
thank you i think i now have an idea on what is happening. i am ready for the challange come tuesday
hi, im having problems with this question as well. can you please help me?
So after deducting the bank charges of 2X0.2 = 0.4, there is still a savings of 1.2%- 0.4% = 0.8% each party.
So now, How much CMC and the counterparty has to pay ?
According to the answer scheme :
“After paying the 20 basis point fee, CMC Co will effectively pay interest at the yield curve rate and benefit by 40 basis points
or 0·4%, and the counterparty will pay interest at 3·4% and benefit by 40 basis points or 0·4% as well.”how did they get 3.4% and that CMC has to pay at the yield rate?
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