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Company A can borrow money at a fixed price of 7.5 percent or a variable rate set at prime plus 1 percent. Company B can borrow money at a variable rate of prime plus .5 percent or a fixed rate of 8 percent. Company A prefers a variable rate and Company B prefers a fixed rate. If the swap dealer requires .5 percent profit what would be a favorable outcome swap between Companies A and B?

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Answer:

The favorable swap between A and B will be:

A borrows fixed a 7.5%, received 7.5% from swap dealer to settle for interest expenses and pay Prime + 0.75% to swap dealer. Thus, the net result is A borrows at variable Prime + 0.75%. A will be benefit from borrowing at variable rate at 0.25% lower.

B borrows at variable Prime + 0.5%, received Prime + 0.5% from swap dealer to settle for interest expenses and pay 7.75% to swap dealer. Thus, net result is B borrows at fixed 7.75%. B will be benefit from borrowing at fixed rate at 0.25% lower.

Money dealer receive from A Prime + 0.75%, from B 7.75%; and paid to A 7.5%, to B Prime + 0.5%. Thus they gain:

Prime + 0.75% + 7.75% - 7.5% - Prime - 0.5% = 0.5%.

Explanation:

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