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Homework answers / question archive / Company X wishes to borrow U

Company X wishes to borrow U

Finance

Company X wishes to borrow U.S. dollars at a fixed rate of interest. Company Y wishes to borrow Japanese yen at a fixed rate of interest. The amounts required by the two companies are roughly the same at the current exchange rate. The companies have been quoted the following interest rates, which have been adjusted for the impact of taxes:

Yen Dollars

Company X 5.0% 9.6%

Company Y 6.5% 10.0%

Design a swap that will net a bank, acting as intermediary, 50 basis point per annum. Make the swap equally attractive to the two companies and ensure that all foreign exchange risk is assumed by the bank.

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Answer:

Total cost of borrowing if Company X borrows in US Dollars and Y borrows in Yen = 9.6%+6.5% = 16.1%

total cost if X borrows in Yen and Y borrows in US Dollars under swap = 5.0%+10% = 15%

Savings under swap = 1.1%

Intermediary = 0.5%

Shared by each company = 0.6%/2 = 0.3%

Effective cost of borrowing will be

X = 9.6% - 0.3% = 9.3%

Y = 6.5%-0.3% = 6.2%

PFA

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