Company A is a blue chip company, headquartered in United State. It is consideri
ID: 2791838 • Letter: C
Question
Company A is a blue chip company, headquartered in United State. It is considering raising $500 million to fund its major expansion in a whole new sector for the next 20 years. Company A can either borrow at a fixed rate of 11% or at a floating rate of prime rate + 7%. Given company A's own projection of its new business, it prefers to borrow at floating rate.
Company B is multi-national corporation based in France. It is also considering raising $500 million to expand its business in United States for the next 20 years. Company B can either borrow at a fixed rate of 15% or at a floating rate of prime rate + 9%. Company B prefers to borrow at fixed rate.
Explain the comparative advantage between company A and company B when it comes to borrowing.
Suppose you represent a swap bank and now both companies ask you to create an interest rate swap that would help both company save 0.8% in the interest annually. (Company A save 0.8% in floating rate and company B save 0.8% in fixed rate)
Explanation / Answer
Answer:
Company A Company B Princial $M 500 500 Fixed Rate 11% 15% Floatin prime+7% Prime+9% Preference Floating Fixed Savigs by Swap 0.80% 0.80% Savings in $M 4 4 No Swap Prime Rate 5% Interest Outgo $M 60 75 Swap New Interest Fixed Floating Swap @ Prime rate 4% Prime Rate 4% Interest Outgo $M 51 61 Savings 9 14 Swap @ Prime rate 5% Prime Rate 5% Interest Outgo $M 51 66 Savings 9 9 Explantion Note that since the compnay A is optimistic about its growth and if it forecasts interest rates to fall in future it would be better to opt for floating rates. Also since the company is palced in US and dealing with dollars it does not require to consider currency fluctuations. For company B it is placed in France and wanted to do business in US. Hence it shall face two risks. Interest rate risk and currency risk If interest rates are falling in US while $ is appreciating against Franc the company B ends in paying more money in interest. Also no indication is made in the question about growth scenario of firm B. Hence Company A is having higher comparitive advantage than when compared to Company B If company B is sure of falling interest rates and either stable or deprecating $ rate against Franc it shall opt for Floating rate.Related Questions
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