Bank A needs to borrow $10 million to finance a floating rate Eurodollar loan to its client. To avoid the interest rate risk, floating rate note (FRN) is preferable. Company B needs to borrow $10 million to finance an investment project. To avoid the interest rate risk, a fixed rate loan is preferable. Bank A can borrow at a fixed rate of 10.0% and a floating rate of LIBOR flat. Company B can borrow at a fixed rate of 12.5% and a floating rate of LIBOR + 1.0%. A swap bank is used as an intermediary for the deal. The swap bank and the two counterparties of the deal agree that they are going to equally split the total gains from the swap deal.
a. Compute the quality spread differential (QSD).
b. If Bank A agrees to pay LIBOR flat to the swap bank, what interest rate should Bank A receive from the swap bank?
c. If Company B agrees to pay 10.50% fixed rate to the swap bank, what interest rate should Company B receive from the swap bank?