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3. Table 2 contains borrowing rates faced by Pingel Plc and Fereday Plc: Table ...

May 10, 2024

1 Solution

Identifying Comparative Advantage: Pingel Plc has a comparative advantage in fixed-rate borrowing, and Fereday Plc has a comparative advantage in floating-rate borrowing

Structuring the Swap: Pingel Plc will pay a fixed rate to the financial intermediary, and Fereday Plc will pay a floating rate to the financial intermediary. The financial intermediary will then swap these payments

Calculating the Swap Rates: Pingel Plc pays 5.0% fixed to the intermediary, and Fereday Plc pays 6-Month SONIA + 0.6% (0.5% + 0.1% spread) floating to the intermediary

Intermediary's Role: The financial intermediary receives fixed payments from Pingel and floating payments from Fereday, and it swaps these payments, keeping a spread of 0.1%

1 Answer

Pingel Plc enters into a swap to pay 5.0% fixed, and Fereday Plc enters into a swap to pay 6-Month SONIA + 0.6% floating, with the financial intermediary facilitating the swap and earning a 0.1% spread.

Key Concept

Interest Rate Swap

Explanation

An interest rate swap is a financial derivative instrument in which two parties agree to exchange one stream of interest payments for another, based on a specified principal amount.

2 Solution

Comparative Advantage Explanation: Each company has a lower cost in one type of borrowing compared to the other

Benefit of the Swap: By entering into a swap, each company can benefit from the other's lower borrowing cost, after adjusting for the financial intermediary's spread

Swap Rationale: The swap allows both Pingel Plc and Fereday Plc to exploit their comparative advantages and reduce their overall borrowing costs

2 Answer

The comparative advantage argument for the swap is that each company can utilize the other's lower borrowing cost to minimize their own, which leads to a reduction in overall borrowing costs for both parties involved.

Key Concept

Comparative Advantage in Swaps

Explanation

The rationale for the swap is based on the comparative advantage that each company holds in different types of borrowing, allowing them to minimize costs through the swap agreement.