Exam 14: Interest Rate and Currency Swaps

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown below: A swap bank is involved and quotes the following rates five-year dollar interest rate swaps at 10.05%-10.45% against LIBOR flat. Assume company Y has agreed,but company X will only agree to the swap if the bank offers better terms. What are the absolute best terms the bank can offer X,given that it already booked Y?

A swap bank has identified two companies with mirror-image financing needs (they both want to borrow equivalent amounts for the same amount of time.Company X has agreed to one leg of the swap but company Y is "playing hard to get".

A major that can be eliminated through a swap is exchange rate risk.

Explain how firm B could use the forward exchange markets to redenominate a 2-year €40m 5% euro loan into a 2-year USD-denominated loan.

Show how your proposed swap would work for firm A.(e.g.if you were acting as an agent for the swap bank,try to "sell" firm A on your swap) I would point out that his contracting costs would be less with just having 1 swap instead of 2 forward contracts.Also,he might be able to get a better rate through the swap if he can't find forward contracts at his desired maturity and amounts.

What would be the interest rate?

In a currency swap

When an interest-only swap is established on an amortizing basis

Floating for floating currency swaps

Consider the dollar- and euro-based borrowing opportunities of companies A and B . A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit.Firm A wants to borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year.The spot exchange rate is $2.00 = €1.00 and the one-year forward rate is given by IRP as: .Suppose they agree to the swap shown at right.Is this mutually beneficial swap equally fair to both parties?

Explain how firm B could use two of the swaps offered above to hedge its exchange rate risk.

Devise a direct swap for A and B that has no swap bank.Show their external borrowing.Answer the problem in the template provided.

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow £5,000,000 fixed for 5 years.The exchange rate is $2 = £1 and is not expected to change over the next 5 years.Their external borrowing opportunities are: A swap bank wants to design a profitable interest-only fixed-for-fixed currency swap.In order for X and Y to be interested,they can face no exchange rate risk What must the values of A and B in the graph shown above be in order for the swap to be of interest to firms X and Y?

Explain how firm A could use the forward exchange markets to redenominate a 2-year $60m 7% USD loan into a 2-year euro denominated loan.

Pricing a currency swap after inception involves

When a swap bank serves as a broker:

An interest-only single currency interest rate swap

Company X and company Y have mirror-image financing needs (they both want to borrow equivalent amounts for the same amount of time.Company X has a AAA credit rating,but company Y's credit standing is considerably lower.

Act as a swap bank and quote bid and ask prices to A and B that are attractive to A and B and promise to make at least 20bp for your firm.

In an efficient market without barriers to capital flows,the cost-savings argument of the QSD is difficult to accept,because