Company A, a low-rated firm, desires a fixed-rate, long-term loan. A currently has access to floating interest rate funds at a margin of 1.5% over LIBOR. Its direct borrowing cost is 13% in the fixed-rate bond market. In contrast, company B, which prefers a floating-rate loan, has access to fixed-rate funds in the Eurodollar bond market at 11% and floating-rate funds at LIBOR + ½%.
a. How can A and B use a swap to advantage?
b. Suppose they split the cost savings. How much would A pay for its fixed-rate funds? How much would B pay for its floating-rate funds?