Finance 4040

November 3rd, 2020

Ravi Patel

C14 Homework

A. Calculate the quality spread differential (QSD).

QSD = Fixed Rate differential – Floating rate differential

= (12%-10.5%) – (LIBOR + 1%-LIBOR)

= (1.5%-1%)

= (0.5%)

B. Develop an interest rate swap in which both Alpha and Beta have an equal cost savings in
their borrowing costs. Assume Alpha desires floating-rate debt and Beta desires fixed-rate debt.
No swap bank is involved in this transaction.

The QSD is 0.5% as calculated above. The overall benefit to the company is 50%, split

evenly among the Alpha and Beta at .25% each. At this time no swap bank is needed in this

interest swap rate.

Alpha issued fixed rate debt at beta = 10.5%

Beta needs to issue floating rate debt at LIBOR = 1%

Alpha needs to pay LIBOR to Beta, Beta pays 10.75% (10.5%+.25%) to alpha

Calculating the alpha floating alpha rate cost:

 Alphas floating–rate all in cost = 10.5%+LIBOR-10.75%

=LIBOR-0.25

Calculating the beta fixed rate cost:

Betas fixed rate all in cost = LIBOR + 1% + 10.75%

=LIBOR + 11.75%

=.25% Saving over issuing fixed rate debt.

(2) Do problem 1 over again, this time assuming more realistically that a swap bank is involved

as an intermediary. Assume the swap bank is quoting five-year dollar interest rate swaps at 10.7–

10.8 percent against LIBOR flat.

A. 10.5% + LIBOR – 10.7% = LIBOR – 20% (A will save .20% in contrast to

issuing floating rate debt on its own)

B. LIBOR + 1% + 10.8% - LIBOR = 11.8% (B will save .20% in contrast to

issuing fixed rate debt on its own)

C. In conclusion both firms will be saving .20%