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Company Huskey wants to borrow £25m for three years and is offered a variable rate loan commencing on 1st April 2014 at an interest rate of LIBOR + 3%, with interest re-set every six months. The company is particularly risk averse and would prefer a fixed rate loan and has a return requirement is 9% per annum.

Company Oasis also wishes to borrow £25m for three years. It believes that interest rates are likely to remain stable over the period and is happy to pay floating rate interest in exchange for receiving fixed rate payments.

Assume that Company Huskey and Company Oasis arrange a derivative to be transacted on the 1st April 2014 so that Company Huskey pays fixed interest over the period and Company Oasis pays floating rate interest over the period. Assume that the fixed interest rate agreed for it is LIBOR + 7% (fixed at inception), that LIBOR is 0.5% on 1st April 2014 and that on 30 June 2014 the LIBOR rate rises from 0.5% to 1%.

Describe the derivative trade that would enable such an exchange, the reasons why each company might want to transact such a derivative and calculate what the swap rate would be for Company Huskey at inception.

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