IBM and GE are both in the market for approximately $10 million of debt for a five year-period. GE has an AA credit rating while IBM has a single A rating. GE has access to both fixed and floating interest rate debt at attractive rates. However, GE would prefer to borrow at floating rates. Although IBM can borrow at both interest rates, the fixed rate debt is considered expensive. IBM would prefer to borrow at fixed rates. The information about the two firms is summarized as follows:
Credit Rating AAA A
Floating Rates LIBOR + ¼% LIBOR + ¾%
Fixed Rates 9% 10%
Preference Floating Fixed
Please answer the following questions:
1. In what type of borrowing does IBM have the comparative advantage? Why?
2. In what type of borrowing does GE have the comparative advantage? Why?
3. If a swap were arranged, what is the maximum savings that could be divided between the two parties?
4. Please arrange such a swap so that the total saving is divided evenly between the two parties. No financial institution is needed. Please use arrows and boxes to illustrate the deal.
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