The cost to IBM and KDB of accessing either fixed rate yen or the floating rate

Question

The cost to IBM and KDB of accessing either fixed rate yen or the floating rate dollar market for a new debt issue is as follows:

Fixed rate Yen Available

Floating rate Dollar Available

Libor + 0.80%

Libor + 0.25%

Suppose IBM would like to borrow fixed rate yen, whereas KDB would like to borrow floating rate dollars. Assuming a notional principle equivalent to $125 million and a current exchange rate of Yen105/$, what do these possible cost savings translate into in Yen terms (total value)?

Fixed rate Yen Available

Floating rate Dollar Available

Libor + 0.80%

Libor + 0.25%

Explanation / Answer

GIVEN THAT IBM WOULD LIKE TO BORROW FIXED RATE YEN AND KDB WOULD LIKE TO BORROW FLOATING RATE DOLLARS.WE FIND THAT IBM ENJOYS ABSOLUTE ADVANTAGE OVER KDB IN BOTH THE MARKETS.HOWEVER THE DEGREE OF ADVANTAGE IN FLOATING MARKET IS HIGHER.SO IBM HAS A COMPARATIVE ADVANTAGE IN FLOATING MARKET.

SO IBM SHOULD BORROW @ FLOATING RATE( LIBOR+0.25%) DOLLAR AND KDB SHOULD BORROW @ FIXED RATE (4.9%) YEN AND THEN ENTER INTO A SWAP.

EFFECTIVE COST WITHOUT THE SWAP= 4.5%+LIBOR+0.8% = LIBOR+5.3%

EFFECTIVE COST WITH THE SWAP = 4.9%+LIBOR+0.25% = LIBOR+5.15%

SO, OVERALL GAIN = 5.3%-5.15% = 0.15% (TO BE SHARED EQUALLY THAT IS COST DUCTION)

=0.075% EACH

SO, EFFECTIVE COST OF IBM = 4.5%-0.075% = 4.425%

EFFECTIVE COST OF KDB = LIBOR+0.80%-0.075% =LIBOR+0.725%

NOTIONAL PRINCIPLE = $ 125 MILLION

EXCHANGE RATE:

1 $ = 105 YEN

SO $ 125 MILLION = 105*125 MILLION YEN = 13,125 MILLION YEN

SO OVERALL GAIN IN YEN TERMS = 13,125 MILLION YEN * 0.15% = 19.6875 MILLION YEN

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