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 Inc. and Exela Inc. are both seeking funding at the lowest cost possible. Aceable prefers floating rate borrowing, while Exela seeks fixed rate borrowing. One key factor in determining the funding cost advantage enjoyed by Aceable is its better credit rating compared to Exela. This higher creditworthiness allows Aceable to access lower financing costs in both the floating and fixed-rate debt markets. The rates offered to Aceable and Exela in the floating and fixed interest markets are as follows:
  • Aceable: Floating Interest = LIBOR + 0.5%, Fixed Interest = 2%
  • Exela: Floating Interest = LIBOR + 1.5%, Fixed Interest = 4%

Funding Cost Advantage Calculation

The funding cost advantage for Aceable can be calculated by finding the difference between the cost of floating rate borrowing and fixed-rate borrowing. For Aceable, this translates to 2% - (LIBOR + 0.5%). This difference represents the opportunity for improvement in funding costs that can benefit both Aceable and Exela. The funding cost advantage enjoyed by Aceable is crucial in designing a swap arrangement that benefits both parties.

Suggested Funding Type

Based on the analysis above, the suggested type of funds for Aceable is floating rate debt, given its lower financing cost in the floating rate market. On the other hand, Exela should opt for fixed rate debt due to higher costs in the floating rate market. By aligning their funding types with their respective financing advantages, both companies can optimize their funding costs effectively.

Designing a Swap Arrangement

To create a swap arrangement between Aceable and Exela, we utilize the savings resulting from Aceable's funding cost advantage. By sharing these savings equally, both companies can lower their funding costs and meet their preferences for interest rate payments. The swap arrangement aims to balance the benefits of floating and fixed-rate debt for Aceable and Exela, ensuring a mutually beneficial arrangement for both parties.

Net Swap Payments Calculation

With a notional value of $100 million, a 4-year maturity, and a current LIBOR rate of 1% p.a., we can calculate the net swap payments for each year. Assuming a fixed rate of 2% in the swap contract and varying LIBOR rates over the next 4 years (1.2%, 1.5%, 1.8%, and 2%), we can determine the direction and amount of payments made by Aceable and Exela in each year. The net swap payments reflect the optimization of funding costs through the swap arrangement, ensuring a favorable outcome for both companies.
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