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CA Final · Advanced Financial Management · Derivatives Analysis and Valuation

Two firms can borrow at these rates. Aarav Ltd: fixed 9%, floating MIBOR + 1%. Bhavya Ltd: fixed 11%, floating MIBOR + 2%. Aarav wants floating-rate funds and Bhavya wants fixed-rate funds. They enter a swap in which each firm borrows where it has the comparative advantage, and the total gain from the swap is shared equally. Ignoring intermediary fees, what is Aarav's effective floating-rate cost after the swap?

Aarav's effective cost is MIBOR plus 0.5%. The quality spread differential is 2% minus 1%, which is 1%. Shared equally, each firm gains 0.5%. Aarav's direct floating cost of MIBOR plus 1% therefore falls by 0.5%.

  1. AMIBOR + 0.5%Correct
  2. BMIBOR + 1.0%
  3. CMIBOR + 1.5%
  4. DMIBOR − 0.5%

Explanation

The fixed-rate differential is 2% (11% − 9%) and the floating-rate differential is 1% (2% − 1%). The quality spread differential is therefore 2% − 1% = 1%, and each firm gains 0.5%. Aarav's floating cost of MIBOR + 1% falls by 0.5% to MIBOR + 0.5%. MIBOR + 1.0% ignores the gain.

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