Question 2 Southwest Airlines wants to borrow pounds, and BBA pounds at 10%, whe

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Question 2 Southwest Airlines wants to borrow pounds, and BBA pounds at 10%, whereas BBA can borrow dollars at 9% and pounds at 896. Aviation wants to borrow dollars IS better known in the U.S., it can borrow on its own dollars at 7% and Dollar($)- Denominated Debt Pound(E)- Denominated Debt 10% 8% Borrower Southwest Airlines (U.S) BBA Aviation (U.K.) 7% 9% Suppose Southwest wants to borrow £10 million for two years, BBA wants to borrow $15 million for two years, and the current (S/E) exchange rate is $1.50. Assume the counterparties would exchange principal and interest payments with no rate adjustments A. What swap transaction would accomplish this objective? A) BBA will borrow $15 million for two years and Southwest will borrow £10 million for two years. Then the two companies swap their proceeds and payment streams. B) BBA will borrow dollars at 9% and Southwest will borrow pounds at 10%. Then the two companies will swap the 1% difference in interest rates. C) Southwest will borrow dollars at 7% and BBA will borrow dollars at 9%. Then the two companies will swap the 2% difference in interest payments on dollars. D) Southwest will borrow $15 million for two years and BBA will borrow £10 million for two years. Then the two companies swap their proceeds and payment streams E) None of the above. B. What savings are realized by Southwest Airlines from the swap with BBA Aviation? A) B) C) D) E) 1 % or £100,000 annually 2% or £200,000 annually 3% or £300,000 annually 2% or $200,000 annually 1% or $100,000 annually

Explanation / Answer

1.

Southwest is an US company and BBA is an British company. Southbest requires 10 million pound to borrow while BBA requires $10 million. current exchnage rate is $1.50 per pound. So notional principle of both company is same. southwest can borrow borrow dollar at 7% and borrow pound at 10%, while BBA can borrow dollar at 9% and pound at 8%.

Both company has made a SWAP agreement and exchnage their interest rate. So southwest borrow dollar at 7% and give to BBA and BBA borrow 10 million pound at 8% and give to southwest.

So, option (D) is correct answer.

b.

Saving for southwst on pound borrowing is 2% (10% - 8%) and total amount is 200,000 pound.

Option (B) is correct answer.

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