ISWAP is a nonfinancial firm with a weak financial condition. Local banking institutions are willing to offer ISWAP only variable-rate loans. A fixed-rate loan would be more desirable, in light of a long-term investment in a new product that is contemplating. USWAP is a large, strongly capitalized bank in a nearby city that would benefit from variable-rate funding for its short-term asset portfolio. The opportunities to borrow funds for the two parties is as follows:

Variable Rate Fixed Rate

ISWAP (firm) LIBOR + 1% 14%

USWAP (bank) LIBOR + 0.5% 12%

From this information, it is clear that ISWAP pays a 2 percent premium for fixed-rate funds but only a 0.5 percent premium for variable-rate funds.

Assume that an intermediary is contacted to handle the details of the swap. ISWAP takes out a variable-rate loan at LIBOR + 1 percent but swaps this loan's payments with USWAP, who issues seven-year notes at 12 percent. ISWAP pays USWAPs interest bill plus 0.1 percent fee to the intermediating bank. USWAP pays the LIBOR component of ISWAP's variable-rate loan and leaves the fixed 1 percent to be paid by ISWAP.

1. Make a table showing ISWAP's costs, ISWAP's savings from the swap, show the intermediary's fees and the receipts and payments. What is the feasibility of the swap?

2. Make a table showing USWAP's costs, USWAP's savings from the swap, show the intermediary's fees and the receipts and payments. What is the feasibility of the swap?