Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown below: A swap bank proposes the following interest only swap: X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 10.05%. Y will pay the swap bank interest payments on $10,000,000 at a fixed rate of 10.30% and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of LIBOR - 0.15%. What is the value of this swap to the swap bank?
A)The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year.
B)The swap bank will earn 10 basis points per year on $10,000,000 = $10,000 per year.
C)The swap bank will LOSE money.
D)None of the above

Question

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown below:  A swap bank proposes the following interest only swap: X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 10.05%. Y will pay the swap bank interest payments on $10,000,000 at a fixed rate of 10.30% and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of LIBOR - 0.15%.  What is the value of this swap to the swap bank?
A)The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year. 
B)The swap bank will earn 10 basis points per year on $10,000,000 = $10,000 per year. 
C)The swap bank will LOSE money. 
D)None of the above

Quizplus · Accepted Answer

The swap bank will earn a fixed rate of 10.05% from X and pay a fixed rate of 10.30% to Y, resulting in a spread of 25 basis points. At the same time, the swap bank will pay LIBOR-0.15% to Y and receive LIBOR from X, resulting in a spread of 15 basis points. Therefore, the total spread for the swap bank is 40 basis points per year on $10,000,000, which equals $40,000 per year. This makes choice A the correct answer.

Company X Wants to Borrow $10,000,000 Floating for 5 Years;