Kath and Kim each wish to borrow $5 million for five years, but Kath prefers to borrow at fixed rate while Kim prefers floating.However,Kim has a higher credit ratingand has an absolute advantage in borrowing at both floating and fixed rate.They have obtained the following quotations for borrowing:

Fixed Rate

• Kath: 4% p.a.
• Kim: 3% p.a.

Floating Rate

• Kath: Libor + 0.5% p.a.
• Kim: Libor - 0.25% p.a.

A swap dealer quotes a mid-rate of 3.4% p.a. against Libor and pays 5 basis points less than the mid-rate and receives 5 basis points more.

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 i)    Design an on-market plain vanilla swap which will reduce both Kath and Kim's borrowing costs and provide them with their preferred form of borrowing. Indicate what values are required for the letters A to F on the above diagram.

    ii)   By engaging in this swap, how much will Kath be able to reduce her cost of borrowing below the market alternative for her preferred borrowing type?

Transcribed Image Text:

Kath E A C Swap Dealer B D Kim F Kath E A C Swap Dealer B D Kim F

Answer rating: 100% (QA)

To design an onmarket plain vanilla swap that will reduce Kath and Kims borrowing costs and provide them with their preferred form of borrowing we nee... View the full answer