Question 1 (50 marks)
Leopard Automobile is a car manufacturing company and Road Creation is a 4A advertising firm. Leopard Automobile is looking for a floating rate loan, while Road Creation targets a fixed rate loan. The two companies have been offered the following borrowing rates on a $100 million 2-year loan:
Fixed rate (p.a.) Floating rate (p.a.) Leopared Automobile 6.25% LIBOR + 4.75% Road Creation 5.00% LIBOR + 2.1%
Required:
a What is the interest rate difference in borrowing a fixed rate loan between the two companies? What is the difference in borrowing a floating rate loan? Which company has a comparative advantage in the fixed rate loan and which company has a comparative advantage in the floating rate loan? Please explain. (10 marks)
b Suppose you are the Manager of the Bank and the two companies are your long-time customers. Design a swap structure that will allow your bank to be an intermediary with 0.40% per annum profit, and that both Leopard Automobile and Road Creation can benefit equally. (16 marks)
c If Road Creation agrees to engage the swap contract with the Bank according to the structure you proposed, evaluate the firmâs net borrowing cost. Compared with direct borrowing in the market, how many percentage points can Road Creation save from the swap contract? (12 marks)
Question 1 (50 marks)
Leopard Automobile is a car manufacturing company and Road Creation is a 4A advertising firm. Leopard Automobile is looking for a floating rate loan, while Road Creation targets a fixed rate loan. The two companies have been offered the following borrowing rates on a $100 million 2-year loan:
Fixed rate (p.a.) | Floating rate (p.a.) | |
Leopared Automobile | 6.25% | LIBOR + 4.75% |
Road Creation | 5.00% | LIBOR + 2.1% |
Required:
a What is the interest rate difference in borrowing a fixed rate loan between the two companies? What is the difference in borrowing a floating rate loan? Which company has a comparative advantage in the fixed rate loan and which company has a comparative advantage in the floating rate loan? Please explain. (10 marks)
b Suppose you are the Manager of the Bank and the two companies are your long-time customers. Design a swap structure that will allow your bank to be an intermediary with 0.40% per annum profit, and that both Leopard Automobile and Road Creation can benefit equally. (16 marks)
c If Road Creation agrees to engage the swap contract with the Bank according to the structure you proposed, evaluate the firmâs net borrowing cost. Compared with direct borrowing in the market, how many percentage points can Road Creation save from the swap contract? (12 marks)