solution

Consider two firms AAA and BBB. Each firm needs to borrow $1M. AAA wants to borrow at a fixed interest rate while BBB wants to borrow at a floating interest rate. AAA can borrow either at 7% or LIBOR+2% and BBB can borrow either at 6% or at LIBOR +1.5%. The companies entered into a swap agreement in which both companies borrowed $1M from outside lenders. According to the swap agreement, one of the companies pays the other one annual interest payments equal to LIBOR rate times $1M in exchange for fixed-rate payments of x% times $1M. Given that this swap agreement is beneficial for both firms, find the maximum and minimum possible value for x.