A public utility has a relatively low credit $($BBB$)$ rating. It

would like to match its long$-$

term assets with long$-$term, fixed$-$rate debt, but it finds

long$-$term, fixed$-$rate funding

expensive. An oil company has as a higher $($AA$)$ credit rating. It

can issue fixed rate debt at

low cost, but prefers to issue short$-$term commercial paper to fund

its credit card receivables.

The Treasurers of the two companies know one another and agree to

do the swap without

using a bank as an intermediary

The public utility $($BBB$)$ can borrow in the bond market at $6\mathrm{.}5\%$ and

can obtain a floating$-$rate

loan from its bank that reprices annually at SOFR$+0\mathrm{.}50\%.($SOFR is

the Secured Overnight

Financing Rate $$ the new benchmark interest rate for dollar$-$based

lending.$)$ The oil

company $($AA$)$ can issue bonds at $4\mathrm{.}85\%$ or issue A$1/$P$1-$rated

commercial paper at $5$ basis

points below SOFOR $($at SOFR $0\mathrm{.}05\%).$

a$)$ Set up a possible swap among these two firms. Show the potential

gains, if

any, to each party from the swap.

b$)$ What are the risks, if any, to each party to this swap? $($Be

specific.$)$

A public utility has a relatively low credit $($BBB$)$ rating. It would like to match its longterm assets with long$-$term, fixed$-$rate debt, but it finds long$-$term, fixed$-$rate funding expensive. An oil company has as a higher $($AA$)$ credit rating. It can issuc fixed rate debt at low cost, but prefers to issue short$-$term commercial paper to fund its credit card receivables.

The Treasurers of the two companies know one another and agree to do the swap without using a bank as an intermediary

The public utility $($BBB$)$ can borrow in the bond market at $6\mathrm{.}5\%$ and can obtain a floating$-$rate loan from its bank that reprices annually at SOFR $+0\mathrm{.}50\%.($SOFR is the Secured Overnight Financing Rate $-$ the new benchmark interest rate for dollar$-$based lending.$)$ The oil company $($AA$)$ can issue bonds at $4\mathrm{.}85\%$ or issue A$1/$P$1-$rated commercial paper at $5$ basis points below SOFOR $($at SOFR $-0\mathrm{.}05\%).$

a$)$ Set up a possible swap among these two firms. Show the potential gains, if any, to each party from the swap.

b$)$ What are the risks, if any, to each party to this swap? $($Be specific.$)$