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Answer: C
The comparative advantage in swaps arises from differences in borrowing spreads between fixed and floating rates. **Analysis:** - Company C has absolute advantage in both markets (lower rates in both) - Company C's comparative advantage is in fixed rate: 10% vs 12% = 2% advantage - Company C's disadvantage in floating rate: LIBOR+50bps vs LIBOR+100bps = 0.5% disadvantage - Company D's comparative advantage is in floating rate: 0.5% advantage **Total potential savings calculation:** - Without swap: C pays 10% fixed, D pays LIBOR+100bps - With optimal arrangement: C borrows floating (LIBOR+50bps), D borrows fixed (12%) - Through swap, C can pay fixed at less than 10%, D can pay floating at less than LIBOR+100bps - Total quality spread differential = (12% - 10%) - (0.5% - 0%) = 2% - 0.5% = 1.5% Therefore, the total potential savings from the swap is 1.5%.
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Two companies, C and D, have the borrowing rates shown in the following table.
| Company | Fixed Borrowing | Floating Borrowing |
|---|---|---|
| C | 10% | LIBOR+50bps |
| D | 12% | LIBOR+100bps |
According to the comparative advantage argument, what is the total potential savings for C and D if they enter into an interest rate swap?
A
0.5%
B
1.0%