103_2010_0_b - IFIMANB/103/2010 COLLEGE OF ECONOMIC AND...

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IFIMANB/103/2010 COLLEGE OF ECONOMIC AND MANAGEMENT SCIENCES DEPARTMENT OF FINANCE AND RISK MANAGEMENT AND BANKING INTERNATIONAL FINANCIAL MANAGEMENT (IFIMANB) TUTORIAL LETTER 103/2010 CONTENTS 1 INTRODUCTION 2 SOLUTION TO ASSIGNMENT 02 3 EXAMINATION FORMAT 4 CONCLUDING REMARKS
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IFIMANB/103 Dear Student 1 INTRODUCTION The purpose of this tutorial letter is to provide you with solutions to compulsory assignment 02 and the examination format. 2 SOLUTIONS TO ASSIGNMENT 02 Solution to Question 1: The key and necessary condition giving rise to a swap is that a quality spread differential (QSD) should exist. The QSD is the difference between the default-risk premium on the fixed fixed-rate debt and the default-risk premium on the floating rate debt. In this example the T-bill rate default-risk premium can be considered as the proxy to the default-risk premium on the fixed-rate debt. Therefore, he quality spread differential is [(T-bill + 1 5/8 (13/8) percent) minus (T-bill + 4/8 (1/2) percent) =] 9/8 percent minus [(LIBOR + 5/8 percent) minus (LIBOR + 1/8 percent) =] 5/8 percent. If the swap bank receives 1/8 percent, each counter-party is to save 2/8 percent. Given that QSD exists, it is possible for each counter-party to issue the debt alternative that is least
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103_2010_0_b - IFIMANB/103/2010 COLLEGE OF ECONOMIC AND...

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