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OFS Assignment II
COMPARATIVE COST ADVANTAGE:
Fixed
10.7% (AAA Eurobonds)
Rabobank (AAA)
B.F. Goodrich (BBB-)
Rabobanks
Advantage
Floating
LIBOR + 0.25% (foreign
government guaranteed
Notes)
LIBOR + 0.5%
1.80%
0.25%
For the $125000 one time payment, lets assume that a fixed rate coupon is being
paid annually.
Discounting rate used = 10.70% ( =11% annual rate compounded annually)
Cost of Financing:
Before the swap:
Rabobank cost of financing = LIBOR +0.25 (Floating Foreign Govt. Guaranteed
Notes)
B.F. Goodrich cost of financing = 12.5% (BBB industrial Bond Rate)
After the Swap:
Rabobank cost of financing =
Range of X and F:
For the deal to be attractive to all parties, the three equations from 1 to 3 should
be satisfied.
Solving those,
X should be greater than -0.25%. But since it makes no sense for Rabobank to
pay the discount (i.e. x<0), so x should be greater than 0. (otherwise no incentive
for Rabobank)
X should be less than 1.276 % (otherwise no incentive for B.F. Goodrich and/or
Morgan)
F should be greater than zero (otherwise no incentive for Morgan)
F should be less than 1.276 % (otherwise no incentive for Rabobank and/or B.F.
Goodrich)
Hence, 0% < x < 1.276%
And 0 < F < 1.276%
In this case, the risk due to defaults in payment from B.F Goodrich to Rabobank
has been absorbed by Morgan Bank for which it takes a fee from B.F Goodrich.
As it is, there is no defaulting risk concerning Rabobank as it is being paid more
by Morgan Bank than it is paying it.
All the three parties are gainers in this transaction. However from the above
equations, we can see that, F + x < 1.276.
Since the values of F and x are unknown, exact gains of the parties involved
cant be said.