Problem
(Plain vanilla interest rate swap.) Companies A and B both plan to borrow £15m for 7-years. The companies face differing borrowing costs. Company A can borrow for a fixed rate of 9% per annum or a floating rate of LIBOR+100b.p. per annum. Company B can borrow for a fixed rate of 11% per annumor a floating rate of LIBOR+120b.p. per annum.
• Under what conditions would companies A and B find an interest rate swap beneficial? Suppose that the necessary conditions hold and that you are employed by a financial intermediary to arrange interest rate swaps. Propose a swap agreement which would benefit both companies and the intermediary.