Prime-Tec Ltd, an Australian biomedical firm, wishes to borrow US dollars at a floating rate of interest, while Black Inc., a US investment firm, wishes to borrow Australian dollars at a fixed rate of interest. The companies have been quoted the following interest rates:

- USD Rates:
- Prime-Tec Ltd: LIBOR + 3.0%
- Black Inc: LIBOR + 1.0%

- AUD Rates:
- Prime-Tec Ltd: 7.5% Fixed
- Black Inc: 7.0% Fixed

If the swap dealer earns 20 basis points per annum, how much would Prime-Tec Ltd. pay/receive from the bank under a swap agreement that lowers the borrowing costs equally for both firms?

Choose one of the following options:

A. Pay AUD fixed at 6.85%
B. Receive AUD fixed at 6.85%
C. Pay USD floating at LIBOR + 2.35%
D. Receive USD floating at LIBOR + 2.35%

To lower borrowing costs equally for both firms, a cross-currency interest rate swap is needed. The swap dealer will act as an intermediary and facilitate the exchange of interest payments between Prime-Tec Ltd. and Black Inc.

The swap agreement would involve the following:

Prime-Tec Ltd:

- Pays fixed AUD at 7.5%

- Receives floating USD at LIBOR + 2.35%

Black Inc:

- Pays fixed USD at 7.0%

- Receives floating AUD at AUDIBOR + 2.35%

To calculate the net cash flow for Prime-Tec Ltd. under the swap agreement:

Net Cash Flow = Fixed AUD - Floating USD

Net Cash Flow = 7.5% - (LIBOR + 2.35%)

As the swap dealer earns 20 basis points per annum, the final cash flow for Prime-Tec Ltd. would be:

Net Cash Flow = 7.5% - (LIBOR + 2.35%) - 0.20%

Similarly, the net cash flow for Black Inc. would be:

Net Cash Flow = 7.0% - (AUDIBOR + 2.35%) - 0.20%

The swap agreement aims to equalize borrowing costs for both firms, so the net cash flow for both should be the same.

Given the choices provided:

- Pay AUD fixed 6.85% is the same as 7.5% - 0.65% (AUDIBOR + 0.35% - 0.20%), which matches the net cash flow for Prime-Tec Ltd.

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