Goodrich-Rabobank Interest Rate Swap Essay -- Economics Economy Essays

Goodrich-Rabobank Interest Rate Swap1. How large should the discount (X) be to make this an attractive deal for Rabobank?2. How large must the annual fee (F) be to make this an attractive deal for Morgan Guaranty?3. How small must the combination of F and X be to make this an attractive deal for B.F. Goodrich?4. Is this an attractive deal for the savings banks?5. Is this a deal where everyone wins? If not, who loses?IntroductionPlayers Morgan Bank, Rabobank, and B.F. Goodrich, Salomon Brothers,Thrift Institutions and Saving BanksGoodrichIn early 1983, Goodrich needed $50 million to fund its ongoingfinancial needs. However, Goodrich was reluctant to borrow ( get around termdebt) from its committed bank lines because of the following reasons1. It would lose positive about of its remaining short term capital availability under its bank lines.2. It would compromise its future flexibility by borrowing in the short term.Instead, it wanted to borrow for an 8 year range (or longe r) at afixed rate.However, since the general level of beguile rates were pretty high,and Goodrich?s conviction ratings had dropped from BBB to BBB-. Goodrichbelieved that it would have to pay 13% affair for a 30 yearcorporate debenture.Salomon Brothers had advised Goodrich that they could borrow in the USpublic debt market with a floating rate debt issue tied to the LIBOR,and then swap payments with Euro market bank that had raised funds inthe fixed-rate Eurobond market.Note The reason that Salomon were confident that this could be doneis described as follows1. There was a recent deregulation of deposit markets had allowed deposit institutions to offer n... ...% - (x1+11.2%) = 1.3%-x1.7. From (2), and (5) Rabobank saves the following amount in semiannual interest payments LIBOR ? 1/8% - (LIBOR ?x2) = x2 ? 1/8%.8. For this deal to occur, Rabobank, Morgan, and Goodrich must profit hence the following also must be truea. (x1-x2)= F where 37.5 F 8 (footnote 2 on page 362).b. 130 ? x1 0 i.e. 130 x1c. X2 ? 12.5 0 i.e. x2 12.5Assuming that x2 = 20 basis, and x1 = 100 basis. We can conclude thefollowingGoodrich pays a fixed interest of 11.2% + 1% = 12.2% a savings of 20basis points (after transaction costs).Rabobank saves a total of 2% - 1.8% = 20 basis points.And Morgan collects 2% - 1.25% = 75 basis points in fee, in additionto the $125,000 one time fee.Note The total savings that this deal provides as a result of theswap is 5 + 20 + 75 = 100 basis points.