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Answer: Yes, because the total gain for all three parties is 40 basis points, which allows for +10 bps to each company after deducting the intermediary fee
Compute the available gain from comparative advantage: - Fixed-rate spread: 5.8% - 5.0% = 0.8% - Floating-rate spread: (LIBOR + 70 bps) - (LIBOR + 30 bps) = 40 bps The swap gain is the difference between the two spreads: - 80 bps - 40 bps = 40 bps The investment bank requires a 20 bps fee, leaving 20 bps to be shared between the two counterparties. That means each company can receive 10 bps of benefit. So the swap is **advisable and profitable** for all three parties, and the correct answer is **C**.
Author: Manit Arora
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Q-174.3. An intermediacy (investment bank) considers entering into two swap transactions, one with each of Company A and Company B. Company A is the better credit risk and can borrow at 5.0% in the fixed market and LIBOR + 30 basis points in the floating market. Company B can borrow at 5.8% in the fixed market and LIBOR + 70 basis points in the floating market. Company A wants to borrow at floating rates; Company B wants to borrow at fixed rates. The intermediacy will only enter into the swaps if it can earn a fee of 20 basis points per annum. Is the swap advisable and profitable to all three counterparties?
A
No, because the total gain possible for all three parties is negative 40 basis points (-40 bps), so the swap is not advisable
B
No, because the total gain possible for all three parties is negative 90 basis points (-40 bps), so the swap is not advisable
C
Yes, because the total gain for all three parties is 40 basis points, which allows for +10 bps to each company after deducting the intermediary fee
D
Yes, because the total gain for all three parties is 60 basis points, which allows for +20 bps to each company after deducting the intermediary fee
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