Funding Cost Advantage and Swap Arrangement between Aceable Inc. and Exela Inc.
a) Describe and calculate the funding cost advantage enjoyed by Aceable, which represents the opportunity set for improvement in funding costs to be distributed between both parties. b) Based on your analysis in part a), please suggest the type of funds (fixed or floating) for Aceable and Exela. c) Using the savings as a result of Aceable’s funding cost advantage and assuming that both firms share the savings equally, design a swap arrangement between Aceable and Exela that meets their preferences for interest rate payments and also results in a lower funding cost for both companies. d) Assume that the notional value of the swap arrangement is $100 million, the maturity of the agreement is 4 years, and the current LIBOR rate is 1% p.a. In a table, show the net swap payments in each year and which party makes a payment, if the fixed-rate is 2% in the swap contract and the LIBOR rate over the next 4 years is 1.2%, 1.5%, 1.8% and 2%.
a) To calculate the funding cost advantage enjoyed by Aceable, we compare the financing costs in the debt markets for both companies. Aceable's cost of floating rate borrowing is LIBOR + 0.5%, while Exela's is LIBOR + 1.5%. The cost of fixed rate borrowing for Aceable is 2%, and for Exela is 4%.The funding cost advantage for Aceable can be calculated as the difference between the cost of floating rate borrowing and the cost of fixed-rate borrowing, which is 2% - (LIBOR + 0.5%). This represents the opportunity set for improvement in funding costs that can be distributed between both companies. b) Based on the analysis in part a), the suggested type of funds for Aceable is floating rate debt since it has a lower financing cost in the floating rate market compared to the fixed rate market. For Exela, the suggested type of funds is fixed rate debt since it has a higher financing cost in the floating rate market. c) To design a swap arrangement between Aceable and Exela, we can use the savings resulting from Aceable's funding cost advantage. Assuming the savings are shared equally, we can allocate a portion of the savings to reduce the funding cost for both companies. d) Assuming a notional value of $100 million, a maturity of 4 years, and a current LIBOR rate of 1% p.a., we can calculate the net swap payments in each year based on the fixed rate of 2% in the swap contract and the LIBOR rates over the next 4 years. Year 1: Net swap payment = (LIBOR rate - fixed rate) * notional value = (1.2% - 2%) * $100 million = -$800,000 (Aceable makes a payment) Year 2: Net swap payment = (1.5% - 2%) * $100 million = -$500,000 (Aceable makes a payment) Year 3: Net swap payment = (1.8% - 2%) * $100 million = -$200,000 (Aceable makes a payment) Year 4: Net swap payment = (2% - 2%) * $100 million = $0 (No payment)
Description of Funding Cost Advantage for Aceable
- Aceable: Floating Interest = LIBOR + 0.5%, Fixed Interest = 2%
- Exela: Floating Interest = LIBOR + 1.5%, Fixed Interest = 4%