Reference no: EM132958527
The top management of Alpha plc is very optimistic about the COVID-19 pandemic, given the successful vaccination programme in the country. The general feeling is that the economy is expected to bounce back stronger very soon, consequently interest rates should rise. Alpha requires funding of £100 million for 5 years and has obtained the following quotes from their banker:
- Variable rate at LIBOR + 0.45% per annum or
- Fixed rate at 5.7% per annum.
A financial institution, Middleton, has a customer, Omega Ltd, that has similar loan requirements as Alpha. Omega Ltd forecasts that interest rates will decline from the worsening pandemic. Omega has two options from its banker:
- Variable rate at LIBOR + 1.3% per annum or
- Fixed rate at 5.95% per annum.
Middleton has approached Alpha and Omega, and suggested that the three firms (Alpha, Omega and Middleton) could conduct a plain vanilla swap that would benefit all parties in the proportion of 40 percent, 40 percent and 20 percent respectively. Alpha and Omega will eventually borrow from their banks using variable rates and fixed rates respectively.
Required:
a) Compute the benefit derived by each party for the plain vanilla swap, and the midinterest rate for the fixed leg of the swap.
b) Sketch a fully-labelled diagram for the swap.
c) Compute the final loan rates paid by Alpha and Omega.
d) Discuss the similarities and differences between a plain vanilla swap and a forward rate agreement.
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