CAS Exam 9 Spring 2014, Question 9
Study guide: Exam 9
Companies A and B both want to borrow $50 million for 10 years and are offered the following annual borrowing rates:
| Floating | Fixed | |
|---|---|---|
| Company A | LIBOR – 0.2% | 4.3% |
| Company B | LIBOR + 0.9% | 5.4% |
Part a (0.5 points)
Explain why the comparative advantage argument does not provide a benefit to this pair of companies when borrowing from the floating and fixed interest rate markets.
Part b (2 points)
Assume instead that the following interest rates are available for each company:
| Floating | Fixed | |
|---|---|---|
| Company A | LIBOR – 0.1% | 4.1% |
| Company B | LIBOR + 0.9% | 5.4% |
Devise a swap agreement that is mutually beneficial to both companies and creates a 0.06% gain to a financial institution serving as an intermediary.
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