Purchase Solution

# Interest Rate Swap

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Assume that Company A has a fixed rate of 6.00% and a floating rate of LIBOR +1.40% and Company B has a fixed rate of 7.00% and a floating rate of LIBOR + 1.70%. Determine how these companies could engage in an interest rate swap to decrease their cost of financing. (Hint: you will need to assume an agreed upon rate that makes this swap possible) What would you expect to happen to the spreads in the floating and fixed rate markets?

##### Solution Summary

Sets up a fixed rate for floating rate interest rate swap.

##### Solution Preview

Assume that Company A has a fixed rate of 6.00% and a floating rate of LIBOR +1.40% and Company B has a fixed rate of 7.00% and a floating rate of LIBOR + 1.70%.  Determine how these companies could engage in an interest rate swap to decrease their cost of financing.  (Hint: you will need to assume an agreed upon rate that makes this swap possible)  What would you expect to happen to the spreads in the floating and fixed rate markets?

Fixed Floating
A 6.00% LIBOR + 1.40%
B 7.00% LIBOR + 1.70%
Difference 1.00% 0.30%

QSD =Quality Spread Differential= 0.70% =1.% -.3%

For swap to happen, let us assume that A would like to borrow folating rate and B would like to borrow fixed rate
(Otherwise the swap will ...

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