Firm A can borrow at 4% fixed or in the floating-rate market at Libor flat. Firm B can borrow at 7% fixed or at Libor $+ 100$ bps. A wants to borrow floating and B fixed. Suppose that to reduce financing costs, A borrows fixed, B borrows floating, and they enter into an interest-rate swap. Which of the following statements is valid?
A) The combined improvement in cost of financing to A and B with the swap is always equal to the difference between the fixed rate differential (between A and B) and the floating rate differential which in this case is 200 basis points.
B) The combined improvement in cost of financing to A and B with the swap is always equal to the floating rate differential, which in this case is 100 basis points.
C) The combined improvement in cost of financing to A and B with the swap depends on the negotiated fixed rate on the swap between the two counterparties.
D) No improvement in combined financing costs is possible-what one party gains in financing costs, the other party loses.

Question

Quizplus · Accepted Answer

The combined improvement in cost of financing to A and B with the swap is always equal to the difference between the fixed rate differential (between A and B) and the floating rate differential which in this case is 200 basis points.

Firm a Can Borrow at 4% Fixed or in the Floating-Rate