Final answer:
The quality spread differential (QSD) indicates the additional borrowing cost for a lower-rated company compared to a higher-rated company. Without a direct comparison of the same LIBOR index, we know Company B pays less spread over its preferred six-month LIBOR compared to Company A's three-month LIBOR + 165 basis points, illustrating credit rating influence on borrowing costs.
Step-by-step explanation:
To determine the quality spread differential (QSD) between Company A and Company B, we must compare the spreads over LIBOR that each company pays on its preferred index. Company A, which has a higher credit rating (AAA), can issue five-year floating rate notes (FRNs) at three-month LIBOR + 165 basis points (since this is their preferred index). Conversely, Company B, with a lower credit rating (A), can issue five-year FRNs at six-month LIBOR + 100 basis points (their preferred index).
To calculate the QSD, the difference between the spreads of the two companies is taken based on their preferred LIBOR indexes:
For Company A (AAA-rated): three-month LIBOR + 1.65%
For Company B (A-rated): six-month LIBOR + 1.00%
Since the indexes differ (three-month vs. six-month), a direct comparison is not possible. However, we can deduce that Company B would pay a lower spread relative to its preferred index than Company A. If we could convert the spreads to a common index, we could then calculate the exact QSD.
The QSD is important because it reflects the additional amount a lower-rated company (like Company B) must pay to borrow, compared to a higher-rated company (like Company A), illustrating the impact of credit ratings on borrowing costs in the financial markets.