16. Swap Markets

1. In a “plain vanilla” swap there is an agreement between two parties to:

Swap fixed interest rate payments for floating rate interest payments. Swap payments in one currency for payments in another currency. Floating rate payments based on Treasury bond interest rates for floating rate payments based on LIBOR. Fixed rate payments based on Treasury bond interest rates for fixed rate payments based on LIBOR.

2. You are given the following potential borrowing costs between two companies.

	Fixed Rate	Floating Rate
Company A	Treasury Bond + 2%	$LIBOR + 3%
Company B	Treasury Bond + 3%	$LIBOR + 2.5%

Assuming Company A wishes to borrow $100 million at a floating rate and Company B wishes to borrow $100 million at a fixed rate. As part of the Swap arrangement Company A borrows at Treasury Bond+2% and Company B at $LIBOR+2.5%. Which of the following represents the most beneficial Swap arrangement for Company B?

Company A services Company B at $LIBOR+2.5% and Company B services Company A debt at Treasury Bond+2%. Company A services Company B at $LIBOR+2.6% and Company B services Company A debt at Treasury Bond+2.2%. Company A services Company B at $LIBOR+2.7% and Company B services Company A debt at Treasury Bond+2.1%. Company A services Company B at $LIBOR+2.8% and Company B services Company A debt at Treasury Bond+2.3%.

3. You are given the following potential borrowing costs between two companies.

	Fixed Rate	Floating Rate
Company A	Treasury Bond + 2%	$LIBOR + 2%
Company B	Treasury Bond + 3%	$LIBOR + 2.5%

Assume Company A wishes to borrow £100 million at a floating rate and Company B wishes to borrow £100 million at a fixed rate. Which of the following statements is TRUE?

Company A has a comparative advantage in the floating market and an absolute advantage in both fixed and floating. Company A has a comparative advantage in the fixed market and an absolute advantage in both fixed and floating markets. Company B has a comparative advantage in the fixed market. A mutually beneficial Swap is not feasible.

4. You are given the following potential borrowing costs between two companies.

	Fixed Rate	Floating Rate
Company A	Treasury Bond + 3%	$LIBOR + 2.5%
Company B	Treasury Bond + 1%	$LIBOR + 1%

Assume Company A wishes to borrow £100 million at a fixed rate and Company B wishes to borrow £100 million at a floating rate. As part of a Swap deal, Company B borrows from the market fixed and Company A borrows from the market floating. What is the net saving to Company A if as part of a Swap agreement it pays Company B Treasury Bond fixed plus 2% and Company B pays Company A LIBOR+1.8%.

0.3% 1.8% 1.5% 3.2%

5. You are given the following potential borrowing costs between two companies in two currencies. Company A wishes to borrow fixed and Company B wishes to borrow floating.

	UK Pound Fixed Rate	US Dolloar Floating Rate
Company A	9%	$LIBOR + 1%
Company B	11%	$LIBOR + 3.5%

Which of the following statements is FALSE?

A mutually beneficial Swap is possible. Company A has an absolute advantage in both currencies. Company A has a comparative advantage in the US dollar floating market. Neither company has a comparative advantage in either fixed or floating markets.

Check Answers