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Goodrich-RabobankInterest Rate Swap:

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Introduction

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. ...read more.

Middle

Morgan was merely agreeing to act as a conduit assuming no default payments. In fact, if Goodrich defaulted it could not collect the floating rate stream from Morgan. The swap was a two way or no way transaction. This was true for the bilateral agreement between Rabobank, and Morgan also. Morgan had an AAA credit rating, and an international reputation, this guarantee effectively lowered whatever credit risk might have otherwise been present in the swap agreement to acceptable levels for Rabobank. In commissions, Morgan received an initial one time fee of $125,000.00, 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. Salomon Brothers: Salomon advised Goodrich to look into the possibility of issuing a LIBOR associated floating rate debt, and eventually underwrote the first part of the Swap transaction by selling the BF Goodrich floating rate note in the US bond market. ...read more.

Conclusion

Therefore, 6. From (1), and 4, Goodrich saves the following amount in semiannual interest payments : 12.5% - (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. ...read more.

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