FINA 441 –MULTINATIONAL FINANCIAL MANAGEMENT

Assignment 2 – Spring 2023

Interest Rate Swaps
 This assignment is worth 7% of the overall grade including class presentation of 1%.
 Please upload on blackboard your report (one page) by 13/04/2023. Calculations to be
done on excel and uploaded simultaneously.

Suppose your company has been rated by Moody’s as Aa. Consequently, you can borrow
from your local bank USD 10M (or any amount depending on your needs reflected in
assignment 1) for a five-year term at the following rates:
 Fixed-rate borrowing cost 10.5%
 Floating-rate borrowing cost LIBOR

Now suppose your competitor’s company has been rated by Moody’s as Baa. They can
borrow from their local bank USD 10M (the same amount that you have chosen) for a five-
year term at the following rates:
 Fixed-rate borrowing cost 12.0%
 Floating-rate borrowing cost LIBOR + 1%

Part 1: (2.5 Points)

a. Calculate the quality spread differential (QSD).
Answer:

Calculation of QSD
QSD= (Borrowing Fixed cost of Aa - Borrowing Fixed cost of Baa) -
(Libor+1%-LIBOR)
QSD= (12%-10.5%) -(1%)
QSD= 0.5%

b. Specify what are your current borrowing terms and the reason why you want to
change those terms.
Answer:
A fluctuating rate determined by LIBOR or a fixed rate of 10.5% is now available as
terms for borrowing. While my company pays 10.5% for fixed-rate borrowing and
LIBOR for floating-rate borrowing, my competitors pay 12% and LIBOR+1%,
 accordingly. Agreement adjustments will benefit both my company and competing
companies.
c. Suppose you know your competitor and agree with them to engage in an interest rate
swap. Develop an interest rate swap in which both counterparties have an equal cost
savings in their borrowing costs. Assume you desire floating-rate debt and your
competitor desires fixed-rate debt. No swap bank is involved in this transaction.
Answer:
My company must offer fixed-rate debt at a rate of 10.5%, competitors must charge
LIBOR + 1% for floating-rate financing. Our business still owes the competitor's
LIBOR. Furthermore, they must pay my company 10.75%. If this agreement is
implemented, the total cost of the floating-rate debt owed by my company will be
LIBOR+-0.25% or 10.5+LIBOR-10.75%. This 25% cost is held by delivering the
floating rate debt cost. Competitors' total fixed-rate debt expenses are LIBOR+1%
+10.75%-LIBOR or 11.75%. Nevertheless, there is a 0.25% cost savings compared to
fixed-rate costs of debt.

Part 2: (2.5 Points)

Solve 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% against LIBOR flat. Do not forget to specify the benefit of the swap
bank.
Answer:
Competitors would charge LIBOR + 1% for floating-rate debt, my business will charge
10.5% for fixed-rate debt. My company will receive 10.7% from the swap banks in addition
to LIBOR. The competitor will receive the money from LIBOR and pays the swap banks
10.8%. As a result, my company will pay a variable rate loan cost of 1.5% + LIBOR 10.7% =
LIBOR -.2%. A floating-rate loan has a 2% lower cost of issuance. Issuing fixed-rate debt
expenses saves 2% in comparison to the fixed-rate debt cost associated with the competition,
meaning that LIBOR+1% + 10.8% = 11.8%.
(1 Point) Please mention the risks of your transaction.
Answer:
Price risk and risk of default are inherent in every transaction. The overall index and rate
amongst the competition as well as price risk are the factors that offer the biggest effects on
transactions.