Tutorial 4 workshop question
Firm A currently pays a fixed amount of interest of £4.5m pa on the
£100m nominal value of its long term debt. Firm B currently has
£100m nominal of floating rate debt at LIBOR + ½%.
Firm A wishes to switch to a floating rate and firm B wishes to switch
to a fixed rate.
A swap dealer’s bid-ask spread in exchange for LIBOR is 2.95% -
3.15% for firm A and 3% - 3.1% for firm B.
i. Show the details of the swap arrangement, and the net
outcome for the firms and the dealer.
Firm A
Dealer
pays LIBOR + LIBOR
receives 2.95% 2.95% Firm B
+3.1% pays 3.1%
LIBOR receives LIBOR
Net 0.15%
Firm
Existing debt
payments
Pay to
swap
Receive
from swap
Net debt
payments
A 4.5% + LIBOR - 2.95% = LIBOR + 1.55%
B LIBOR+0.5% + 3.1% - LIBOR = 3.6%
Firm A has converted to a floating rate and firm B has converted to a
fixed rate. Dealer earns 0.15% which is the average of the 2 spreads.
