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

Goodrich-Rabobank Interest Rate Swap 1. 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? Introduction: Players: Morgan Bank, Rabobank, and B.F. Goodrich, Salomon Brothers, Thrift Institutions and Saving Banks Goodrich: In early 1983, Goodrich needed $50 million to fund its ongoing financial needs. However, Goodrich was reluctant to borrow (short term debt) from its committed bank lines because of the following reasons: 1. It would lose substantial 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 longer) at a fixed rate. However, since the general level of interest rates were pretty high, and Goodrich?s credit ratings had dropped from BBB to BBB-. Goodrich believed that it would have to pay 13% interest for a 30 year corporate debenture. Salomon Brothers had advised Goodrich that they could borrow in the US public debt market with a floating rate debt issue tied to the LIBOR, and then swap payments with Euro market bank that had raised funds in the fixed-rate Eurobond market. Note: The reason that Salomon were confident that this could be done is described as follows: 1. 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 true: a. (x1-x2)>= F where 37.5> F> 8 (footnote #2 on page 362). b. 130 ? x1> 0 i.e. 130> x1 c. X2 ? 12.5> 0 i.e. x2> 12.5 Assuming that x2 = 20 basis, and x1 = 100 basis. We can conclude the following: Goodrich pays a fixed interest of 11.2% + 1% = 12.2% a savings of 20 basis 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 addition to the $125,000 one time fee. Note: The total savings that this deal provides as a result of the swap is: 5 + 20 + 75 = 100 basis points.