Question

Question 6

Suppose firm ABC has access to fixed rate 7.5%, and floating rate of Euribor + 1.5%, while XYZ had access to fixed rate 7% and floating rate Euribor + 0.5%. For these two firms:
For these two firms, if a swap would work, and if we ignore the cut to a swap dealer, the total amount both firms combined could gain is:

		0.5%
		1.0%
		1.5%
		It can vary depending on how they split

Answer 1

Solution :

XYZ firm has an advantage both in terms of fixed rate and floating rate Interest.

Difference in Fixed rates of ABC & XYZ = ( 7.5 % - 7 % ) = 0.5 %

Difference in floating rates of ABC & XYZ ( Euribor + 1.5 % ) - ( Euribor + 0.5 % ) = 1 %

In order for a swap to be worked out between these two firms :

1. XYZ firm will now opt for floating rate loan at ( Euribor + 1.5 % )

     This arrangement will result in a gain of 1 % to both the firms.

2. ABC firm will now opt for fixed rate loan at 7.5% .

    This arrangement will result in a loss of 0.5% to both the firms.

Thus the total amount both firms combined could gain = 1 % - 0.5 % = 0.5 %.