Question 2: Swaps The cost to IBM and KDB of accessing either fixed rate yen or

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Question 2: Swaps

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. Answer part (a), (b) (c) and (d) below:

A)Identify the overall spread (basis point) of the swap and at what rate should each party borrow to create the swap? IBM has comparative advantage in which rate? (3 marks)

B)What is the fixed rate Yen at which IBM can borrow through interest rate/currency swap if KDB can borrow at IBM’s floating rate of Libor+0.25%? (2 marks)

C)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)? (2 marks)

D)Assuming that Bank of American is the intermediary and charges a fee of 8 basis points to arrange the swap. If IBM realises all the saving from the swap then what is IBM borrowing cost and what is the cost savings translate into Yen terms? (3 marks)

Fixed rate Yen Available

Floating rate Dollar Available

Libor + 0.80%

Libor + 0.25%

Explanation / Answer

Libor + 0.80%

Libor + 0.25%

The two parties can achieve a combined 15 basis point savings through IBM borrowing floating-rate dollars at LIBOR + 0.25% and KDB borrowing fixed-rate yen at 4.9% and then swapping the proceeds. Therefore, the cost saving for IBM: 4.9% - 4.5% - 0.55% = 0.15% . Thus, the potential savings to IBM range from 0 to 0.15%.
b. The fixed rate Yen at which IBM can borrow through interest rate/currency swap if KDB can borrow at IBM’s floating rate of Libor+0.25%  saving KDB 0.55%, which then passed these savings along to IBM by swapping the fixed-rate yen at 4.9% - 0.55% = 4.35%.
c. At a current exchange rate of Yen105/$, IBM's borrowing would equal Yen 13,125,000,000 (125,000,000 x 105). A 0.15% savings on that amount would translate into Yen 19,687,500 per annum (Yen 13,125,000,000 x 0.0015).

d. The potential savings from a swap net out to 7 basis points. IBM borrowing cost would be reduced to 4.43% (4.5% - 0.07%). The 7 basis point saving would translate into an annual saving of Yen 9,187,500 ( Yen 13,125,000,000 x 0.0007)

Libor + 0.80%

Libor + 0.25%

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