Chapter 7 Problems - CHAPTER 7 Swaps Practice Questions...

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CHAPTER 7 Swaps Practice Questions Problem 7.1. Companies A and B have been offered the following rates per annum on a $20 million five- year loan: Fixed Rate Floating Rate Company A 5.0% LIBOR+0.1% Company B 6.4% LIBOR+0.6% Company A requires a floating-rate loan; company B requires a fixed-rate loan. Design a swap that will net a bank, acting as intermediary, 0.1% per annum and that will appear equally attractive to both companies. A has an apparent comparative advantage in fixed-rate markets but wants to borrow floating. B has an apparent comparative advantage in floating-rate markets but wants to borrow fixed. This provides the basis for the swap. There is a 1.4% per annum differential between the fixed rates offered to the two companies and a 0.5% per annum differential between the floating rates offered to the two companies. The total gain to all parties from the swap is therefore 1 4 0 5 0 9 % per annum. Because the bank gets 0.1% per annum of this gain, the swap should make each of A and B 0.4% per annum better off. This means that it should lead to A borrowing at LIBOR 03 % and to B borrowing at 6.0%. The appropriate arrangement is therefore as shown in Figure S7.1. Figure S7.1 Swap for Problem 7.1 Problem 7.2. Company X wishes to borrow U.S. dollars at a fixed rate of interest. Company Y wishes to borrow Japanese yen at a fixed rate of interest. The amounts required by the two companies are roughly the same at the current exchange rate. The companies have been quoted the following interest rates, which have been adjusted for the impact of taxes:
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Yen Dollars Company X 5.0% 9.6% Company Y 6.5% 10.0% Design a swap that will net a bank, acting as intermediary, 50 basis points per annum. Make the swap equally attractive to the two companies and ensure that all foreign exchange risk is assumed by the bank. X has a comparative advantage in yen markets but wants to borrow dollars. Y has a comparative advantage in dollar markets but wants to borrow yen. This provides the basis for the swap. There is a 1.5% per annum differential between the yen rates and a 0.4% per annum differential between the dollar rates. The total gain to all parties from the swap is therefore 1 5 0 4 1 1 % per annum. The bank requires 0.5% per annum, leaving 0.3% per annum for each of X and Y. The swap should lead to X borrowing dollars at 9 6 0 3 9 3 % per annum and to Y borrowing yen at 6 5 0 3 6 2 % per annum. The appropriate arrangement is therefore as shown in Figure S7.2. All foreign exchange risk is borne by the bank. Figure S7.2 Swap for Problem 7.2 Problem 7.3. A $100 million interest rate swap has a remaining life of 10 months. Under the terms of the swap, six-month LIBOR is exchanged for 7% per annum (compounded semiannually). The average of the bid–offer rate being exchanged for six-month LIBOR in swaps of all maturities is currently 5% per annum with continuous compounding. The six-month LIBOR rate was 4.6% per annum two months ago. What is the current value of the swap to the party paying floating? What is its value to the party paying fixed?
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Chapter 7 Problems - CHAPTER 7 Swaps Practice Questions...

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