Company A can borrow money at a fixed rate of 9.5% or a variable rate set at prime plus 0.5% Company B can borrow money at a variable rate of prime plus 1% or a fixed rate of 9% Company A prefers a fixed rate and company B prefers a variable rate. Given this information, which one of the following statements is correct?
A) Company A can swap with B and pay a fixed rate of 8.75%
B) If Company A swaps with B, Company A will pay a fixed rate between 9 and 9.5%
C) If Company B swaps with A, Company B must pay a fixed rate of 9.5%
D) Company B can swap with A such that Company B pays the variable prime rate.
E) There are no terms under which both Company A and Company B can swap interest rates and both realize a profit.

Question

Quizplus · Accepted Answer

DB) Company A can enter into a swap agreement with Company B where Company A pays a fixed rate that is lower than its own fixed borrowing rate of 9.5% but higher than Company B's fixed borrowing rate of 9%. This is because swaps allow companies to leverage their comparative advantages in borrowing rates. Company A prefers a fixed rate and can thus swap to pay a rate between 9% and 9.5%, which is beneficial for both parties.D) Company B prefers a variable rate and can enter into a swap with Company A where it pays the variable prime rate. This is possible because Company A prefers a fixed rate and can agree to pay a fixed rate in the swap, allowing Company B to pay a variable rate, which aligns with its preference.

Company a Can Borrow Money at a Fixed Rate of 9.5