Consider the borrowing rates for Parties A and B.

A wants to finance a $100,000,000 project at a fixed rate. B wants to finance a $100,000,000 project at a floating rate. Both firms want the same maturity, 5 years.

Firm Fixed Rate Floating

A $ 10.3% Prime + 1%

B $ 8.9% Prime + 1/2%

Construct a mutually beneficial interest only swap that makes money for A, B, and the swap bank in equal measure

Effective Cost to Firm A = 10.00%

Effective Cost to Firm B = Prime +0.20%

Step-by-step explanation

Firm     Fixed     Floating   Preference of Firm

Firm A  10.30%    Prime +1%    Fixed Rate

Firm B   8.90%   Prime + ½ %  Floating Rate

if We notice Firm B is at Comparative Advantage for Borrowing at both the rates i.e. at Fixed as well as Floating Rates.

Part 1) If Both Firm Borrow the Money according to their Preferences then Overall Cost to both the Firms will be: 10.30% + (Prime + ½%) = 10.30% + Prime +0.50% = 10.80% + Prime 

Part 2) However if Both Firms Borrows Money against their Preference i.e. Firm A Borrows at Floating rate and Firm B Borrows at Fixed Rate, and enters into Interest Rate Swap with Bank, then Overall Cost to both the Firms will be: (Prime +1%) + 8.90% = Prime + 1% +8.90% = 9.90% + prime

Part 3) Over Gain by switching to swap = Overall Cost without Swap - Overall Cost under Swap

= (10.80% + Prime) - (9.90% + prime)

= 10.80% + Prime - 9.90% - Prime

= 0.90%

Part 4) This Overall Gain of swap will be Shared equally by Firm A, Firm B and Bank., so Individual Benefit = 0.90/3= 0.30% to Each

Part 5) Effective Cost to Firms:

Firm A = Preferred Fixed rate - Individual Swap Benefit

= 10.30% -0.30% = 10.00%

Firm B = Preferred Floating Rate - Individual Swap Benefit

= Prime + ½ %  - 0.30%

= Prime +0.50% -0.30%

= Prime +0.20%

Please see the attached file for the complete solution