If your classmates are not willing to share their notes, then I'm happy to share mine with you! These are the notes I collected during the seminar for this topic.
Question 1.
Companies A and B have been offered the following rates per annum on a $20 mil
5-year loan:
Fixed rate Floating rate
A 5.0% SOFR+1.0%
B 6.4% SOFR+0.6%
Company A requires a floating-rate loan while company B requires a fixed-rate loan.
Design a swap that will net a bank, acting as intermediary, 0.1% per annum and that will
appear equally attractive to both companies.
Interest rate swaps - transforming type of liability or asset - ie: fixed to floating rate loan.
Matching - intermediary - helps with timing. Needs to be a benefit for all involved.
In reality - will be less than 0.1% for intermediaries.
Comparative advantage = engage in a swap.
Firm A = less risky - lower floating rate. Short-term, overnight floating rate of interest.
Higher rates of interest are charged if the firm is more likely to default.
The premium = 1.4% points A - B ; floating rate premium = 0.5% (diff between A and B)
B is more risky in the market, but with floating pay lower premium.
Long term = higher fixed rate differential.
Constructing the swap:
A = want floating rate loan, B has comparative advantage ij floating-rate markets, B = want
fixed rate loan where A has comparative advantage in fixed-rate markets.
1.4% per annum differential between the fixed rates offered to A and B and a 0.5% per
annum differential between the offered floating rate.
The total gain to all parties is therefore 1.4-0.5=0.9% per annum
The 0.9% total gain will be split as (to give intermediary 0.1%, and equally attractive to both
firms):
- 0.1% to intermediary
- 0.4% to company A (½ of remaining)
- 0.4% to company B
Will lead to:
A borrowing floating at SOFR - 0.3% ( a gain of 0.4% compared to SOFR+0.1% )
B borrowing fixed at 0.6% ( gain of 0.4% compared to 6.4% )
Company A already pays a fixed rate out.
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller emcevoyp2001. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for £6.99. You're not tied to anything after your purchase.
