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CMA Final · Strategic Financial Management · Swaps

Aravali Ltd can borrow fixed at 10% or floating at MIBOR + 1.5%. Bhavani Ltd can borrow fixed at 11.5% or floating at MIBOR + 2.0%. They enter a swap, with Aravali borrowing in the market where it has comparative advantage, and they share the total quality-spread gain equally. What is the total gain available from the swap?

The total gain is 1.00%. The difference in fixed-rate spreads is 1.5% while the difference in floating-rate spreads is 0.5%; the net quality spread of 1.0% is the benefit to share, giving 0.5% each if split equally.

  1. A1.00%
  2. B0.50%Correct
  3. C1.50%
  4. D0.25%

Explanation

Fixed differential = 11.5 - 10 = 1.5%. Floating differential = 2.0 - 1.5 = 0.5%. Total gain = 1.5 - 0.5 = 1.0%; equal share is 0.5% each. The question asks total gain, which is 1.0%, so check: option 1.00% is index 0. Correcting: total gain = 1.00%.

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