Given the following information: Borrower AAA BBB Fixed rate Floating rate 8.50% p.a. LIBOR 9.20% p.a. LIBOR + 0.50% p.a. The notional principal of the swap agreement is USD 1 million. 1. Explain the concept of notional principal. 2. Under the assumption of no intermediation/no intermediation fees and an equal split of savings (if any), determine whether a profitable interest rate swap could be arranged between AAA Limited and BBB Limited. Explain your reasoning. 3. If a profitable swap is possible, construct a swap that would advantage both parties. Indicate which party should borrow at a fixed rate using a bond issue and which party should borrow at a floating rate via a bank loan.

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