Finance-AW-Q378

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Connecticut Municipal Swap Questions
 

Q1. Read Merrill Lynch’s proposal first. There are two sub-proposals: one with flat fixed rate (FIXED_M) and the other with swap (SYNTHETIC_M). Assume that the State of Connecticut can issue a floater at the interest rate of 55 basis points under JJK index (JJK – 0.55%). In the SYNTHETIC_M proposal, the State will issue the floater and enter interest rate swap with Merrill Lynch simultaneously. The swap says that Merrill Lynch will pay JJK index to the State and the State will pay 6.905% fixed to Merrill Lynch. What is the total interest rate that the State pays if they chose this SYNTHETIC_M structure? How much does it differ from FIXED_M proposal?
 

Q2. Read BT’s proposal. There are two sub-proposals again: one with flat fixed rate (FIXED_B) and the other with swap (SYNTHETIC_B). Assume that the State of Connecticut can issue a floater at the interest rate of 25 basis points under TENR index (TENR – 0.25%). In the SYNTHETIC_B proposal, the State will issue the floater and enter interest rate swap with BT simultaneously. The swap says that BT will pay TENR index to the State and the State will pay 6.67% fixed to BT. What is the total interest rate that the State pays if they chose this SYNTHETIC_B structure? How much does it differ from FIXED_B proposal?
 
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Q3. The case shows that the State can borrow at the fixed rate of 7.06% or borrow at the floating rate of JJK – 0.5%. Suppose Merrill Lynch can borrow at the fixed rate of 7.26% or borrow at the floating rate of JJK. What is the maximum interest rate gain if two parties enter an interest rate swap? If the State follows Merrill Lynch’s SYNTHETIC_M proposal – receives JJK and pays 6.905% to Merrill Lynch – what is the interest rate gain for Merrill Lynch? Draw a swap diagram and explain.
 

Q4. Among the proposals, which seems to be the best option for the State? As a State officer, you should not only consider interest rate savings but also other factors that may affect the welfare of the State.
 

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