suppose that IBM would like to borrow fixed-rate yen, whereas Korea Development

Question

suppose that IBM would like to borrow fixed-rate yen, whereas Korea Development Bank (KDB) would like to borrow floating-rate dollars. IBM can borrow fixed-rate yen at 4.5% or floating-rate dollars at LIBOR + 0.25%. KDB can borrow fixed-rate yen at 4.9% or floating-rate dollars at LIBOR + 0.8%. A- what is the range of possible cost savings that IBM can realize through an interest rate/currency swap with KDB? B- assuming a national principal equivalent to $ 125 million and a current exchange rate of

Explanation / Answer

we can see that IBM has absolute advantage in both the cases but IBM has comparative advantage in floating rate borrowing and KDB has comparative advantage in fixed rate borrowing difference in floating rate = LIBOR + 0.8% - LIBOR + 0.25% = .55% difference in fixed rate = 4.9 -4.5 = .4% thus by entering into the interest rate swap overall cost saving = .55 - .4 = .15% if profits are equally distributed then profit for IBM = .15/2 = .075% B).075/100 * 125000000 * 105 = 9843750 yen

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