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ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against interest rate risk

Beta Ltd can borrow fixed at 6.0% or floating at SOFR + 1.0%. Gamma Ltd can borrow fixed at 5.0% or floating at SOFR + 0.2%. Beta wants floating-rate debt and Gamma wants fixed-rate debt. They agree to swap, with total interest savings shared equally and no bank involved. What is the total gain available from the swap?

The total gain is 0.2%. The gap in fixed borrowing rates is 1.0% while the gap in floating rates is 0.8%; the difference of 0.2% is the comparative advantage that can be shared, giving 0.1% to each party if split equally.

  1. A0.2%Correct
  2. B0.8%
  3. C1.0%
  4. D1.8%

Explanation

Fixed differential = 6.0% - 5.0% = 1.0%. Floating differential = 1.0% - 0.2% = 0.8%. Total gain = 1.0% - 0.8% = 0.2%, so each party saves 0.1%. The 0.8% option uses only the floating gap, and 1.0% only the fixed gap.

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