Suppose IBM would like to borrow fixed-rate yen, whereas Korea Development Bank

Question

Suppose 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 4.75% or floating-rate dollars at LIBOR + 0.35%. KDB can borrow fixed-rate yen at 4.90% or floating-rate dollars at LIBOR + 0.75%.

(a) What is the range of possible cost savings that IBM can realize through an interest rate/currency swap with KDB?

(b) Assuming a notional principal equivalent to $125 million and a current exchange rate of 105/$, what do these possible cost savings translate into in yen terms?

(c) Redo parts a and b assuming the parties use Bank of America, which charges 8 basis points to arrange the swap

Explanation / Answer

A NSWER . 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:

0.45%        = .30% savings

Given the rate differences between the markets, the two parties can achieve a combined 30-basis-point savings through IBM borrowing floating-rate dollars at LIBOR + 0.35% and KDB borrowing fixed-rate yen at 4.9% and then swapping the proceeds. IBM would borrow fixed-rate yen at 4.45% if these savings were passed along in the swap. This could be achieved by IBM providing floating-rate dollars to KBD at LIBOR + 0.35%, saving KDB 0.45%, which then passed these savings along to IBM by swapping the fixed-rate yen at 4.9% - 0.45% = 4.45%. Thus, the potential savings to IBM range from 0% to 0.3%

ANSWER . At a current exchange rate of ¥105/$, IBM’s borrowing would equal ¥13,125,000,000 (125,000,000*105). A 0.3% savings on that amount would translate into ¥39375000 per annum (¥13,125,000,000*0.3%)

ANSWER . In this case, the potential savings from a swap net out to (30-8)22 basis points. If IBM realizes all these savings, its borrowing cost would be lowered to 4.67% (4.75% - 0.08%). The 22 basis-point saving would translate into an annual saving of ¥28875000 (¥13,125,000,000*0.22%)

fixed rate yen available floating rate dollar available KDB 4.90% libor+.80% IBM 4.75% libor+.35% difference 0.15%

0.45%        = .30% savings

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