No Marshmallows, Just Term Papers
FI 473, Section 001-Fall 2011
The B. F. Goodrich-Rabobank Interest Rates Swap Case
1.How large should be the discount (X) to make the deal attractive to Rabobank?
Before the swap, since the Goodrich has a BBB- rating, the cost is about 12.5% if Goodrich
wants to raise capital at a fixed rate. As the Rabobank has a rating of AAA, the fixed rate for it is
Now after the swap, the interest rate for Goldrich is the LIBOR rate + 0.5%. As the swap
payment rate is 10.7%, the total payment to Morgan is 10.7% plus the annual fee which is f. Also
the swap payment of Rabobank received by Morgan is LIBOR – x. As a result, the total cost for
Goodrich is the LIBOR + 0.5% - (LIBOR – x) + 10.7% + f, which equals 11.2% + x + f . The
total cost for Rabobank is 10.7% + (LIBOR - x) -10.7% which is (LIBOR - x).
The benefit of Goodrich from swapping is the difference between borrowing at the rate of
12.5% and the swapping. So 12.5% - (11.2% + x + f) =1.3% - x - f. Both the benefit of Goodrich
(1.3% - x - f) and the annual fee f should be greater than zero. So the x can be no more than 1.3%.
The benefit of Robabank is the difference between the floating rate which is (LIBOR -
0.125%) and the swap cost. LIBOR - 0.125% -(LIBOR - x) = x - 0.125%. This need to be greater
than zero in order to ensure the Robabank’s incentive. So x need to be greater than 0.125%.
Based on the above, the range for x is 0.125% < x < 1.3%.
2.How large should be the annual fee (F) to make this an attractive deal for Morgan
In commissions, Morgan received an initial one time fee of $125,000, and an undisclosed
annual fee for each of the next 8 years. The going rate for such swap transactions has been
between 8 - 37.5 basis points.
According to the exhibit 3, the fixed rate for Goodrich is 12.5% while the fixed rate for
Rabobank is 10.7%. The Rabobank has an advantage on fixed rate of 12.5% - 10.7% which is...