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Answer: Firm C
The oil driller is looking to convert its fixed-rate debt into a floating-rate obligation through a swap. The benefit of the swap is determined by the difference between the fixed-rate spread and the floating-rate spread. The fixed-rate spread is the difference between the oil driller's fixed rate and the firm's fixed rate, while the floating-rate spread is the difference between the oil driller's floating rate and the firm's floating rate. In the provided table, the oil driller has a fixed rate of 4.0% and a floating rate of 6-month LIBOR + 1.5%. Firm A has a fixed rate of 3.5% and a floating rate of 6-month LIBOR + 1.0%. The difference in fixed rates (fixed spread) between the oil driller and Firm A is -0.5%, and the difference in floating rates (floating spread) is 0.5%. The combined benefit is the sum of these differences, which is 0.0%. For Firm B, the fixed spread is 2.0% and the floating spread is 1.5%, resulting in a combined benefit of 0.5%. For Firm C, the fixed spread is 1.5% and the floating spread is 0.5%, resulting in a combined benefit of 1.0%. For Firm D, the fixed spread is 0.5% and the floating spread is 1.0%, resulting in a combined benefit of -0.5%. The greatest combined benefit comes from Firm C, with a combined benefit of 1.0%. Therefore, the oil driller should choose Firm C for the swap to maximize the combined benefit. The correct answer is C. Firm C.
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A company specializing in oil drilling has recently issued $250 million in fixed-rate debt with an annual interest rate of 4.0% to fund a new project. Now, the company intends to convert this fixed-rate debt into a floating-rate debt using a swap agreement. A swap desk analyst from a leading investment bank, known for being a market maker in swaps, has identified four potential companies interested in swapping their floating-rate debt for fixed-rate debt. The following table presents the loan interest rates for the oil drilling company and each of the prospective companies:
| Company | Fixed-rate (in %) | Floating-rate (in %) |
|---|---|---|
| Oil Drilling Company | 4.0 | 6-month LIBOR + 1.5 |
| Company A | 3.5 | 6-month LIBOR + 1.0 |
| Company B | 6.0 | 6-month LIBOR + 3.0 |
| Company C | 5.5 | 6-month LIBOR + 2.0 |
| Company D | 4.5 | 6-month LIBOR + 2.5 |
Identify which company the oil drilling company should engage in a swap with in order to attain the maximum combined benefit.
A
Firm A
B
Firm B
C
Firm C
D
Firm D