Asset Swap Structuring

You work for Swap bank and one of your clients, a small Italian regional bank, wants to use some of its credit lines available to Fucci (an unrated Italian fashion house). You have made them aware of the recent 4-year straight Eurobond issued by Gucci. However, they are not interested in a fixed rate asset but a floating rate EURIBOR asset. Your client is a small bank and is not in a position to enter into swap transactions directly. But then can purchase swapped bonds. The terms of the Fucci bond are:

You have been asked to make a pitch to your client. Your bank is the arranger for the package and wants to make a profit of 10 basis points per annum over the life of the transaction. The Euro swap curve is given below.

Solution:

You initially purchase the bond, swap it and then sell the bond as a synthetic FRN.

The price of the bond is 99.060 and therefore the yield on the bond is 5.27% (given a coupon of 5%). The bank will have to pay a 4 yr swap at 3.71% annually against receiving 6 month EURIBOR. In selling the asset swap package the swap bank will have to pay the client a spread over EURIBOR.

The question is how much can we afford to pay over the EURIBOR whilst earning a target margin of 10 basis points per annum.

The first calculation that we need to make is to convert the fixed rates so that they are on the same basis as the floating rate, i.e. from annual to semi-annual and then onto a money market basis. Using this methodology the bond return turns out to be 5.199% on a semi-annual basis and finally, 5.128% on a money market rate basis. The fixed swap rate becomes 3.676% on a semi-annual basis and then 3.626% on a money market basis.

Therefore Fucci pays the Swap bank 5.128% semi-annually (which is the yield on the bond purchased by the Swap bank). The Swap bank then pays 3.626% semi-annually fixed to the Swap desk (of the bank) in return for EURIBOR and then pays off the spread plus the EURIBOR to the client (Italian regional bank). This spread needs to be 10 basis points per annum, therefore:

5.128% - 3.626% +EURIBOR - (EURIBOR + spread) = 0.10%

Solving the above gives us Spread = 1.4021%

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