Interest rate swap

Practice sheet
Intermediate Corporate Finance

1. Wall company and Table company need to raise funds for capital improvements at their manufacturing plants.

Wall company can borrow funds either at an 8 percent fixed rate or at SBI+2 percent floating rate. Table company can borrow
funds at the debt market either at a 11 percent fixed rate or at SBI+1 percent floating rate.

a. Is there an opportunity here for Wall and Table company to do interest rate swap? Explain!
b. Suppose the dealer in the swaps market demand 2 percent of profit, describe how these two company can do interest rate
swap! Use diagram to expalain your answer!
Interest rate swap
Practice sheet
Intermediate Corporate Finance

2. NECE company and KBC company need to raise funds for capital improvements at their manufacturing plants. NECE company
can borrow funds either at an 5 percent fixed rate or at EURIBOR+2 percent floating rate. KBC company can borrow funds at the
debt market either at a 8 percent fixed rate or at EURIBOR+1 percent floating rate.
a. Is there an opportunity here for NECE and KBC company to do interest rate swap? Explain!
 Yes, because there’s comparative advantage. NECE Company better off with fix rate while KBC Company better of
with floating rate. They have the ability to do interest rate swap because each of the firm have comparative
advantage.
b. Suppose the dealer in the swaps market demand 2 percent of profit, describe how these two company can do interest
rate swap! Use diagram to expalain your answer!
- KBC pays 6,5% fixed rate (less 1,5% than debt market i.r) to swap dealer which by swap dealer it pays only 5%
to NECE (net profit 1,5%)
- NECE pays Euribor + 1,5% (less 0,5% than debt market i.r) to swap dealer which by swap dealer it pays only
Euribor + 1% to KBC (net 0,5% proft)
NECE: FIXED 5% or EURIBOR + 2% Floating Rate
KBC : FIXED 8% or EURIBOR + 1% Florating Rate

Fixed 5% SWAP DEALER Fixed 6,5%

NECE Profit 1,5% fix + 0,5% KBC
floating = 2%
Euribor + 1,5% Euribor + 1%

Fixed 5% Euribor + 1%
Dealer need to take 2% profit. It’s from:
Fix rate spread = 3%/2 = 1,5%
Spread to swap dealer
DEBT MARKET DEBT MARKET
Floating rate spread = 1%/2 = 0,5%
Spread for swap dealer
Total swap dealer profit 2%