Firm A borrows in the fixed interest debt market at its preferred rate of 8.00%pa and agrees to pay Firm B the interest on floating rate debt of BBSW...

Firm A borrows in the fixed interest debt market at its preferred rate of 8.00%pa and agrees to pay Firm B the interest on floating rate debt of BBSW + 2.05%. Simultaneously, Firm B borrows in the short term debt market, which is where it is able to borrow comparatively cheaply at BBSW + 2.15%. It also agrees to pay Firm A interest on fixed rate debt at 10.00%pa.

So, focusing on the cash flows:

• Firm A:

- Pays fixed at 8.00%

- Receives fixed at 10.00%

- Pays BBSW + 2.05%

- Net position of: pays BBSW + 0.05%, which is 0.55% better than what it can do borrowing directly in the floating rate debt market

• Firm B:

- Pays floating at BBSW + 2.15% Page 48 of 58

- Receives floating at BBSW + 2.05% - Pays fixed at 10.00%

- Net position of: pays fixed at 10.10%pa, which is 0.40% better than it can do borrowing directly in the fixed rate debt market 

How does Firm A gain 0.55% and Firm B gain 0.40%?

Thank you :)

This is an example of a match swap

*BBSW can be seen the same as LIBOR*