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In: Business and Management

Submitted By moonsharma
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The B.F. Goodrich-Rabobank
Interest Rate Swap

Rabobank’s Comparative Cost Advantage

Fixed Floating

Rabobank (AAA) 10.70 LIBOR + 0.25%

B.F. Goodrich (BBB-) 12.5% LIBOR + 0.5%
Rabobank’s 1.8% 0.25% advantage Comparative advantage = 1.8% - 0.25% = 1.55% p.a.

Rabobank needs floating rate financing to support its U.S. dollar-denominated floating rate loans.

B.F. Goodrich needs fixed rate financing for long term to support its deteriorating financial condition.

Who should borrow in which market?

Cost of Financing

Before the swap:
Rabobank cost of financing = LIBOR +0.25%
B.F. Goodrich cost of financing = 12.5%

After the Swap

Rabobank cost of financing =
10.7% (interest to investors in Netherlands)
+ (LIBOR - x) (swap payments to Morgan)
- (10.7%) (swap payments received from Morgan)
= LIBOR - x

B.F. Goodrich cost of financing =
LIBOR +0.5% (interest to investors in the U.S.)
+ 10.7% + F (swap payments plus fee to Morgan)
- (LIBOR - x) (swap payments received from Morgan)
= 11.2% + F + x

Swap Transaction Savings

Rabobank savings = 0.25% + x > 0
B.F. Goodrich savings = 1.3% - F - x > 0
Morgan’s fee = F > 0
Total = 1.55% = Comparative cost advantage

Minimum and Maximum for x and F

x should be greater than -0.25% (otherwise no incentive for Rabobank) x should be less than 1.3% (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 1.55% (otherwise no incentive for Rabobank and/or B.F. Goodrich)

Hence, -0.25% < x < 1.3%
And 0 < F < 1.55%

Other Issues

1. Default Risk
2. The evolution of interest rate swaps
3. Derivative exposure of firms


Q1. What are the motivating reasons for the interest rate swap in the current case?

Q2. Draw the swap diagram.

Q3. Assuming hypothetical Libor rates, show the exchange of dollar cash flows.

Q4. Show how the swap transaction savings might be shared among the three parties.…...

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