The cost to IBM and KDB of accessing either the fixed rate yen or the floating r

Question

The cost to IBM and KDB of accessing either the fixed rate yen or the floating rate dollar market for a new debt issue is as follows:

Fixed rate Yen Available

Floating rate Dollar Available

Libor + 0.80%

Libor + 0.25%

Suppose that IBM would like to borrow fixed rate yen, whereas KDB would like to borrow floating rate dollars. Answer part (a), (b) (c) and (d) below:

Identify the overall spread (basis point) of the swap and at what rate should each party borrow to create the swap? IMB has competitive advantage in which rate?

What is the fixed rate Yen at which IBM can borrow through interest rate/currency swap if KBD can borrow at floating rate of Libor+0.25%?

Assuming a notional principle equivalent to $125 million and a current exchange rate of Yen105/$, what do these possible cost savings translate into in Yen terms?

Assuming that Bank of American is the intermediary and charges a fee of 8 basis points to arrange the swap. If IBM realises all the saving from the swap then what is IBM borrowing cost and what is the cost savings translate into Yen terms?

Fixed rate Yen Available

Floating rate Dollar Available

KDM 4.9%

Libor + 0.80%

IBM 4.5%

Libor + 0.25%

Explanation / Answer

Answer: a.&d: The cost to each party of accessing either the fixed-rate yen or the floating-rate dollar market for a new debt issue is as follows:

Floating rate Dollar Available

Given the differences in rates between the two markets, the two parties can achieve a combined 15 basis point savings through IBM borrowing floating-rate dollars at LIBOR + 0.25% and KDB borrowing fixed-rate yen at 4.9% and then swapping the proceeds. IBM would be able to borrow fixed-rate yen at 4.35% if all these savings were passed along to it in the swap. This could be accomplished by IBM providing KDB with floating-rate dollars at LIBOR + 0.25%, saving KDB 0.55%, which then passed these savings along to IBM by swapping the fixed-rate yen at 4.9% - 0.55% = 4.35%. Thus, the potential savings to IBM range from 0 to 0.15%.

b. Assuming a notional principal equivalent to $125 million, and a current exchange rate of

Borrower Fixed-rate yen available

Floating rate Dollar Available

KDB 4.9% LIBOR+0.80% IBM 4.5% LIBOR+0.25% Difference 0.4% 0.55%

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