Interest Rate Swap Case

Goodrich-Rabobank Interest Rate Swap In 1983, both B.F. Goodrich and Rabobank needed to execute external financing in order to raise 50 million dollars for ongoing operations. Goodrich wanted to raise the money through debt financing, but because their bonds were BBB- rated, they would have to pay a steep interest rate for a fixed rate. However, the Solomon brothers had an idea. Goodrich could borrow with a floating rate that was tied to LIBOR and then swap interest payments with a Euromarket bank that had raised funds in the fixed rate Eurobond market. A London bank approached Rabobank and proposed a large fixed rate Eurobond issue with the intention of swapping interest payments with a US corporation. Goodrich offered a 50 million dollar, noncallable 8 year bond, semiannual payments that will pay the LIBOR rate + 50 basis points. On the same day Rabobank issued a 50 million dollar, noncallable 8 year bond with an annual coupon fixed at 11 percent. The two issuers executed a swap with the Morgan Guaranty Bank as an intermediary guarantor. Goodrich agreed to pay Morgan bank $5.5 million once each year for 8 years to cover the 11% fixed coupon. Morgan bank agreed to pay Goodrich 8 years of semiannual payments. It would be the LIBOR minus a discount. Similarly, Morgan bank agreed to pay Rabobank 5.5 million once a year for 8 years and Rabobank agreed to pay the Morgan bank the 8 years of semiannual payments at LIBOR – x. Morgan also received from Goodrich a one-time initial fee of $125,000 and an undisclosed annual fee for the each of next 8 years. Goodrich has to pay out the LIBOR + .5% and gets the LIBOR – x and then subtract the 10.7% which is the fixed rate for AAA Eurobonds that Rabobank will have. So you get that Goodrich will receive x + 11.2%. Morgan has to pay LIBOR – x and get the LIBOR – y + 10.7% - 10.7%. After doing the math, Morgan receives x-y in total fees and they could be anywhere between 8 and 37.5 basis points. Rabobank will