A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit. Fir
ID: 2763412 • Letter: A
Question
A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit. Firm A wants to borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year. The spot exchange rate is $2.00 = €1.00, a swap bank makes the following quotes for 1-year swaps and AAA-rated firms against USD LIBOR:
USD Euro
Bid: 8% Bid: 6%
Ask: 8.1% Ask 6.1%
The firms external borrowing opportunities are:
Euro borrowing | USD Borrowing
a. 7% (euro) 8%(usd)
b. 6% (euro) 9%(usd)
How many basis points (bp) can firms A and B each save by eventering info currencu swaps?
How many bp will the swap bank earn?
PLEASE SHOW ALL WORK INVOLVED IN PROBLEM!
Explanation / Answer
Answer
Currency
Company A (US Based MNC)
Firm B (Italian firm)
Difference
Euro
7%
6%
1%
US Dollar
8%
9%
1%
Total gain from Swap
2%
Swap Bank will ask U.S.-based MNC A to borrow $2,000,000 at 8%. Swap bank will take $2,000,000 from U.S.-based MNC A and will lend it to Italian Firm B at 8.1%. So Swap Bank will earn 0.1% (8.1% - 8%) and Italian Firm B will benefit 0.9% (9% - 8.1%) on $2,000,000 borrowing.
Swap Bank will ask Italian Firm B to borrow € 1,000,000 at 6%. Swap will take € 1,000,000 from Italian Firm B and will lend it to U.S.-based MNC A at 6.1%. So Swap Bank will earn 0.1% (6.1% - 6%) and US Based MNC A will benefit 0.9% (7% - 6.1%) on € 1,000,000 borrowing.
Particulars
Earnings/Benefit
%
Basis point
Swap Bank
USD
(8.1% - 8%)
0.10%
Euro
(6.1% - 6%)
0.10%
0.20%
20
Company A (US Based MNC)
(2% - 0.2%)/2
0.90%
90
Firm B (Italian firm)
(2% - 0.2%)/2
0.90%
90
Total gain from swap
2.00%
200
Currency
Company A (US Based MNC)
Firm B (Italian firm)
Difference
Euro
7%
6%
1%
US Dollar
8%
9%
1%
Total gain from Swap
2%
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