Question

2. Companies AAACorp and BBBCorp have been offered the following rates per annum on a $10 million five-year loan:

Fixed rate Floating rate

AAA Corp 4.0% LIBOR - 0.1%

BBB Corp 5.2% LIBOR - 0.6%

Design an interest rate swap that will make all parties involved (bank, two companies) attractive assuming that BBBCorp wants to borrow at a fixed rate of interest, whereas AAACorp wants to borrow at a flotation rate of interest linked to six-month LIBOR.

Answer 1

Company	Fixed Rate	Floating rate	Preference
AAA	4.00%	LIBOR - 0.1%	Floating
BBB	5.20%	LIBOR - 0.6%	Fixed
Bank activity
Company	Rates received	Rates payable
AAA	LIBOR - 0.1%	4%
BBB	5.20%	LIBOR - 0.6%
Total	LIBOR + 5.1%	LIBOR + 3.4%
Spread avaialble with bank	(LIBOR + 5.1%)-(LIBOR + 3.4%)
Spread avaialble with bank	1.70%
Spread sharing equally	1.70%/3	0.57%
Rates payable by each company
	Paid to Inter-Bank	Spread	Net rates payable
AAA	4%	-0.57%	3.43%
BBB	LIBOR - 0.6%	-0.57%	LIBOR - 1.17%