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If a company that had a floating-rate liability wanted to enter into a swap to achieve...

If a company that had a floating-rate liability wanted to enter into a swap to achieve a fixed-rate cost of funds, it would pay a: A. fixed rate to the counterparty and receive a floating rate in return from the counterparty. B. floating rate to the counterparty and pay a floating rate to the fixed-rate lender. C. floating rate to the counterparty and pay a fixed-rate to the fixed-rate lender. D. floating rate to the counterparty and receive a fixed-rate in return from the counterparty.

why answer is A

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Answer #1

Assume A has a liability of LIBOR +2% .

It wants to pay a fixed rate. He can obtain a loan from a Counterparty with a fixed rate of 5%.

At the same time he can give a loan to the Counter party at LIBOR+2%

In effect he swaps a floating rate loan of (LIBOR +2%)for a fixed rate loan of 5%

There may be another party B which has a liability of 4.5% fixed rate.

B wants to have a Floating rate loan. The Counterparty will offer him a LIBOR +2.5% floating rate loan in exchange for a 4.5% Fixed rate loan.

The Counterparty will get LIBOR+2.5% from B and Pay LIBOR+2% to A.

It will get 5% from A and Pay 4.5% fixed rate to B.

The Counterparty (which may be a Financial Institution) will gain 0.5% on flating loan and 0.5% on fixed loan.

The diagram of SWAP is attached.

A. Pay fixed rate to the counterparty and receive a floating rate in return from the counterparty.

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