1. Consider two hypothetical companies, A and B. Company A is a top-rated AAA company, whereas company B is a lower-rated BBB company. Assume that company A wants to raise debt and pays a floating interest rate, which is usually done to finance short-term receivables and credit that earns a short-term interest rate. Company B, conversely, wants long-term fixed-rate financing, perhaps to finance the purchase of machinery and equipment. The cost to each party of accessing either the fixed-rate or the floating-rate market for a new five-year debt issue is as follows:

 

	Company A	Company B
Floating	LIBOR +0.25%	LIBOR + 0.75%
Fixed	10.8%	12.0%

 

1. a. Is it possible for the two companies to reduce their financing costs through interest rate swaps? Why or why not?
2. 
   
3. b. If your answer to A) is yes, help the companies to arrange a swap contract such that both companies have the same amount of interest savings. What is the risk associated with the swap arrangement?

Answer rating: 100% (QA)

A In order to identify if the swap will be beneficial for both the parties we will calculate the Qua... View the full answer