INTL Inc., a US tech company, needs €80 million; DB GmbH, a German financial ins

Question

INTL Inc., a US tech company, needs €80 million; DB GmbH, a German financial institution, needs ?60 million and UNLV Ltd., a UK manufacturer, needs $100 million. The exchange rates as of today are: E$/€ = 1.25, E?/$ = 0.60 and E?/€ = 0.75. All these firms wish to borrow at fixed interest rates. They are quoted the following rates per annum:

Part i. [10 points] Design a tri-party swap agreement that will involve a bank, acting as intermediary and requiring a 200 basis points (that is 2.00%) per annum.

Part ii. [10 points] What is the profit for the bank from this arrangement?
Part iii. [10 points] What is maximum commission (spread between the interest received and interest paid) that the bank can charge and have the three firms accept the swap arrangement?

Explanation / Answer

PART 1: Swap should be done as follows:

INTL INC : Euros @ 5%(GERMANY)

GmbH : POUNDS @4% (UK)

UNLV : DOLLARS @6% (US)

BANK(intermediary) 2% commision

PART 2: Bank will get 2 prcnt commission

Total cost before swap= 7+9+7=23%

Total cost after swap=5+4+6+2(commission)=18%

Net saving from swap=5%

PART 3: Max commssion = Total saving before bank commssion =7% & after commssion =5%

thus, bank can have additional 1.25% i.e total 3.25% (5% saving divided by 4 =1.25%)

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