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Dear tutor,
Please explain is there any suitable method to approach the question of SWAP.Secondly in answer of Question VENOM page number 183 of Open tuition notes, I am finding it difficult to figure out what does (ii) means
“Possible new terms would e for Venom to receive 13% and pay LIBOR + 3/4%. The net cost would be LIBOR + 3/4% +(14-13)%= LIBOR+ 1 3/4%, which is less than the rate at which the company could raise the floating rate debt.
Mover would then effectively have fixed rate debt at which it could otherwise have such debt.
Please Please Please sir help me out. I am not comfortable with SWAP.
I have tried to solve so many question, watched LSBF videos as well but I don’t know whenever I see the question of SWAP, I can’t find the approach to start up with it.If V and M simply borrowed themselves then (last sentence of this first paragraph) V would pay L + 2 and M would pay 13.5. So in total they would be paying L = 15.
The arrangement for part (1) (1) is that the carry on paying the existing interest and also do this swapping.
So…..V will pay 14% and they will pay M L + 1.5% but they will receive from M 13%
So the net cost to V will be 14 + L + 1.5 – 13 = L + 2.5%And..M will pay L + 1% and they will pay V 13% but they will receive from V L + 1.5%.
So their net cost will be L + 1 + 13 – L – 1.5 = 12.5%So with the swap, the total interest for both of them will be L + 2.5 + 12.5
= L + 14.5%Otherwise it would be L + 15% (in the first line) and so between then they can save 0.5%.
However, if you compare the interest by each in the first line of this answer with what they end up paying, you can see that V is paying 0.5% extra, but M ends up saying 1%. In total it is a saving of 0.5%, but it is not fair that M saves more and V loses!!!
Better if they saved the 0.5% split equally between them – 0.25% each.
For V to save 0.25%, it would mean changing the payments they make to each other. The could do it several ways as long as the end result was the same, and what the answer suggests it for M to still pay V 13%, but to make V pay less to M
At the moment V is paying 0.5% extra by swapping, and we want V to be saving 0.25%. So what we can do is have V pay M less than before – 0.75% less.
That would mean V paying M L + 1.5 – 0.75 = L + 0.75%.If you now repeat the working for the end result you will see that they are both saving 0.25%.
Hope that helps!
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