A-Star Holidays (AH) and B-Star Boats (BB) each need $4 million in funds and are quoted the following rates in the fixed and floating markets. If AH accepts the fixed-rate funds and BB the floating-rate funds, structure a swap where they both benefit equally. Show your calculations. (Total 15 marks)

AH - fixed: 7.3 per cent;       floating: BBSW + 2 per cent;

BB - fixed: 8.3 per cent;        floating: BBSW + 2.4 per cent.

a.  How much can each company reduce their borrowing rates by? 

b.  Provide details of the swap you have structured in a table. Include amounts each pays the market and the other, amounts received from the other and the net result. (10 marks)

c. How much would AH receive from BB if they negotiated to get two third of the total benefit instead?

 

a.) 0.3%

b.) AH will borrow from market at 7.3% fixed rate and pay BBSW to BB. While AH will receive 5.6% from firm BB.

BB will borrow from market at BBSW + 2.4% and pay 5.6% to AH. While receive BBSW from AH.

c.) AH will receive 5.7% from BB

Step-by-step explanation

a.) Here we need to find that how much both company can reduce in their borrowing cost.

We can find the cumulative reduction in borrowing cost by difference between sum of (one firm's floating rate and another firm's fixed rate). Positive of that difference is considered as cumulative reduction.

As we know that both firm's are agreed to share the benefit equally. So, reduction/2 will be the effective reduction in borrowing for both company.

Let's calculate the cumulative reduction (Total benefit) : (BB's fixed rate + AH's floating rate) - (BB's floating rate + AH's fixed rate)

Total benefit = (8.3% + BBSW + 2%) - (BBSW + 2.4% + 7.3%) = 0.6%

Benefit to each firm = 0.6%/2 = 0.3%

B.) Here we know that both firm gets benefit of 0.3% because of swap arrangement.

Effective rate to AH = BBSW + 2% - 0.3% benefit = BBSW + 1.7%

However, AH will borrow at 7.3% fixed rate from market. While their effective rate is BBSW+1.7%.

So, (BBSW+1.7%) -(7.3%) = BBSW - 5.6%

Which means (BBSW - 5.6%) the firm AH will receive 5.6% from BB and will pay BBSW to the firm BB.

So, effective transactions are...

AH will borrow from market at 7.3% fixed rate and pay BBSW to BB. While AH will receive 5.6% from firm BB.

BB will borrow from market at BBSW + 2.4% and pay 5.6% to AH. While receive BBSW from AH.

c.) If AH negotiates for 2/3rd benefit.

Total benefit is 0.6%, If AH negotiates for 2/3rd of 0.6% means 0.4% benefit.

Effective rate to AH = BBSW + 2% - 0.4% benefit = BBSW + 1.6%

However, AH will borrow at 7.3% fixed rate from market. While their effective rate is BBSW+1.6%.

So, (BBSW+1.6%) -(7.3%) = BBSW - 5.7%

Which means (BBSW - 5.7%) the firm AH will receive 5.7% from BB and will pay BBSW to the firm BB.