Consider a Plain Vanilla Interest Rate Swap

question 87

Multiple Choice

Consider a plain vanilla interest rate swap. Firm A can borrow at 8% fixed or can borrow floating at LIBOR. Firm B is somewhat less creditworthy and can borrow at 10% fixed or can borrow floating at LIBOR + 1%. Eun wants to borrow floating and Resnick prefers to borrow fixed. Both corporations wish to borrow $10 million for 5 years. Which of the following swaps is mutually beneficial to each party and meets their financing needs?

• A)Firm A borrows $10 million externally for 5 years at LIBOR; agrees to swap LIBOR to firm B for 8 ½ % fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at 10%.
• B)A borrows $10 million externally for 5 years at LIBOR; agrees to pay 8½% to B for LIBOR fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at 10%.
• C)Since the QSD = 0 there is no mutually beneficial swap.
• D)A borrows $10 million externally at 8% fixed for 5 years; agrees to swap LIBOR to B for 8½% fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at LIBOR + 1%.

---

Definitions:

Socially Distributed

Pertains to the way resources, knowledge, or status are spread across different groups or individuals in a society, often unevenly.

Specialized Knowledge

Expertise or skills in a specific field or domain, typically acquired through education or experience.

Higher Education

Tertiary education that follows the completion of secondary education, such as college or university.

Internal Labor Markets

A labor market within an organization, allowing employees to move between different jobs or levels of responsibility without leaving the employer.