Question

Companies AAA and BBB are offered the following rates per annum on a $5 million 10-year loan. AAA requires a floating-rate loan while BBB requires a fixed-rate loan. Bank of America (BOA) is planning to arrange a fixed-for-LIBOR (= R% & LIBOR exchange) swap with a 20-basis-point spread, which will appear equally attractive to AAA and BBB.

	Fixed Rate	Floating Rate
AAA	8%	LIBOR-0.5%
BBB	7%	LIBOR+0.5%

1. Total gain of the swap is:
2. The net gain of the swap to each company without the F.I. is:
3. The net gain of the swap to each company with the F.I. is:

4. The swap rate that is equally attractive to each company without the F.I. is:

5. The transactions of interest rates that AAA pays to or receives from BOA under the swap are:

(Show % with Pay and Receive)

6. The transactions of interest rates that BBB pays to or receives from BOA under the swap are:

(Show % with Pay and Receive)

7. What is the transformed rate of loan as the net effect of the swap to AAA with the F.I.?

8. What is the transformed rate of loan as the net effect of the swap to BBB with the F.I.?

Answer 1

Strong party=AAA
Becausse low interest rate
Interest rate differential
FiXed leg differential(6-5)=1
Floating rate differential(0.5-0.5)=0
If AAA has fixed rate loan and wants floating rate loan and
If BBB has floating rate loan and wants fixed rate loan then the SWAP can be entered
Since the requirment is satisfied SWAP can e entered
Net interest differential=1-0=1
If nothing is paid to intermediary then AAA=0.5 and BBB=0.5

SWAP operations

AAA	BBB
Payment of interest-5%	Payment of interest -(LIBOR-0.5)
receipt from BBB=(5+0.5)=5.5	receipt from AAALIBOR+0.5
Payment to BBB=-(LIBOR+0.5)	Payment to BBB=-5.5
Total=-LIBOR	Total=6.5

-LIBOR=6.5