Explanation:
C is correct. Since the oil driller is swapping out of a fixed-rate and into a floating-rate, the larger the difference between the fixed spread and the floating spread, the greater the combined benefit. See table below:
| Firm | Fixed-rate | Floating-rate | Fixed-spread | Floating-spread | Possible Benefit |
|---|---|---|---|---|---|
| Oil driller | 4.0 | 1.5 | |||
| Firm A | 3.5 | 1.0 | -0.5 | -0.5 | 0.0 |
| Firm B | 6.0 | 3.0 | 2.0 | 1.5 | 0.5 |
| Firm C | 5.5 | 2.0 | 1.5 | 0.5 | 1.0 |
| Firm D | 4.5 | 2.5 | 0.5 | 1.0 | -0.5 |
A, B, and D are incorrect per the explanation of C above.
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An oil driller recently issued USD 250 million of fixed-rate debt at 4.0% per year to help fund a new project. It now wants to convert this debt to a floating-rate obligation using a swap. A swap desk analyst for a large investment bank that is a market maker in swaps has identified four firms interested in swapping their debt from floating-rate to fixed-rate. The following table quotes available loan rates for the oil driller and each firm:
| Firm | Fixed rate (%) | Floating rate (%) |
|---|---|---|
| Oil driller | 4.0 | 6-month LIBOR + 1.5 |
| Firm A | 3.5 | 6-month LIBOR + 1.0 |
| Firm B | 6.0 | 6-month LIBOR + 3.0 |
| Firm C | 5.5 | 6-month LIBOR + 2.0 |
| Firm D | 4.5 | 6-month LIBOR + 2.5 |
A swap between the oil driller and which firm offers the greatest possible combined benefit?
A
Firm A
B
Firm B
C
Firm C
D
Firm D
