im having trouble figuring out where the swapped rates come from, 6.2% and 6.8%
ID: 2656075 • Letter: I
Question
im having trouble figuring out where the swapped rates come from, 6.2% and 6.8% how are the new rates calculated? Suppose that GE wants to borrow 20 million AUD and Qantas wants to borrow 15 million USD, and that the the current exchange rate is 0.75 USD/AUD. Since in this case 20 million AUD is equivalent to 15 million USD, it creates the perfect environment for a currency swap agreement. Suppose that GE and QA get into the following currency swap agreement. General Electric borrows USD in U.S. market at 5% and Qantas Airways borrows AUD in Australian markets at 8.0%. Then they swap: General Electric gives Qantas USD at 6.2% and Qantas gives General Electric AUD at 6.8%
Explanation / Answer
USD/AUD exhange rate is 0.75 ie USD/AUD = 0.75
=> 1 USD = 0.75 AUD
=> 1 AUD = 1.33 USD
GE wants to borrow 20M AUD from USA which is equal to 20*1.33 USD ie 26.6 M USD
Qantas wants to borrow 15M USD from Australia which is equal to 15*0.75 AUD ie 11.25 AUD
Interest payable by GE to US banks = 26.6M*5% = 1.33M
Interest payable by Qantas to Autralian bank = 11.25*8% = 0.9M
Now to hedge or reduce the forex risk these two companies have entered in to a swap agreement.
Interest receivable by GE = 26.6M * 6.2% = 1.65M USD receivable by GE
Profit from swap = 1.65M-1.33M = 0.32 M USD
Interest received by Qantas= 11.25 * 6.8% = 0.765M AUD receivable by Qantas
Loss from swap= 0.765M -0.9M = -0.135M AUD
Please note here due to this swap Qantas loses but loses less. So swap reduced the risk.
And just for addtional info these Swap rates of 6.2% and 6.8% are usually based on prevailing LIBOR or London Interbank offer rate . The companies use various financial models to find rates ie to mark the interest rate some basis points above or below the LIBOR rate.
Hope this helps!
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