Firm a Can Borrow at 4% Fixed or in the Floating-Rate

question 7

Multiple Choice

Firm A can borrow at 4% fixed or in the floating-rate market at Libor flat.Firm B can borrow at 7% fixed or at Libor $+ 100$ bps.A wants to borrow floating and B fixed. Suppose that to reduce financing costs,A borrows fixed,B borrows floating,and they enter into an interest-rate swap.Which of the following statements is valid?

• A)The combined improvement in cost of financing to A and B with the swap is always equal to the difference between the fixed rate differential (between A and B)and the floating rate differential which in this case is 200 basis points.
• B)The combined improvement in cost of financing to A and B with the swap is always equal to the floating rate differential,which in this case is 100 basis points.
• C)The combined improvement in cost of financing to A and B with the swap depends on the negotiated fixed rate on the swap between the two counterparties.
• D)No improvement in combined financing costs is possible-what one party gains in financing costs,the other party loses.

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