Johnson Corp. has not tapped the Deutsche mark public debt market because of con

Question

Johnson Corp. has not tapped the Deutsche mark public debt market because of concern about a likely appreciation of that currency and only wishes to be a floating rate dollar borrower, which it can be at LIBOR + 1.1%. Apex Corp. strongly prefers fixed rate DM debt, but it must pay 1.6% more than the 6.25% coupon that Johnson’s DM notes would carry. Apex, however, can obtain Eurodollars at LIBOR + 0.5%.

(a) What is the maximum possible cost savings to Johnson from engaging in a currency swap with Apex?

(b) Suppose a bank charges .7% to arrange the swap and Johnson and Apex split the resulting cost savings. Calculate borrowing cost for each company.

Explanation / Answer

(a) What is the maximum possible cost savings to Johnson from engaging in a currency swap with Apex?

Differences are Johnson– Apex

Difference in floating rates is LIBOR+1.10% - LIBOR+0.5% = 0.6%

Difference in fixed rates is 6.25% - 7.85% = -1.6%

First minus second gives us total benefits on offer from swap: 0.6%+1.6% = 2.20%.

(b) Suppose a bank charges .7% to arrange the swap and Johnson and Apex split the resulting cost savings. Calculate borrowing cost for each company.

If bank charges 0.7% that means only 1.5% is left over for the two companies. If this is split evenly, then Johnson gets 0.75% and Apex gets 0.75%.

So Johnson pays LIBOR+1.1% - 0.75% = LIBOR + 0.5%

Apexpays 7.85% - 0.75% = 7.10%

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