Consider the Situation of Firm a and Firm B $$\begin{array} { l l l } & \$ & £ \\\text { A } & \$ 6 \% & £5 \% \\B & \$7 \% & £ 4\%\end{array}$$

Essay

Consider the situation of firm A and firm B.The current exchange rate is $2.00/£ Firm A is a U.S.MNC and wants to borrow £30 million for 2 years.Firm B is a British MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown,both firms have AAA credit ratings.
$$\begin{array} { l l l } & \$ & £ \\\text { A } & \$ 6 \% & £5 \% \\B & \$7 \% & £ 4\%\end{array}$$ The IRP 1-year and 2-year forward exchange rates are $F _ { 1 }$ ($ ∣ £)= $\frac { \$ 2.00 \times ( 1.06 ) } { £ 1.00 \times ( 1.04 ) }$ = $\frac { \$ 2.0385 } { £ 1.00 }$ $F _ { 2 }$ ($ ∣ £)= $\frac { \$ 2.00 \times ( 1.06 ) ^ { 2 } } { £ 1.00 \times ( 1.04 ) ^ { 2 } }$ = $\frac { \$ 2.0777 } { £ 1.00 }$ USD pounds
$$\begin{array} { c c c c } \text { Bid } & \text { Ask } & \text { Bid } & \text { Ask } \\6\% & 6.1 \% & 4 \%& 4 .1\%\end{array}$$ Explain how firm A could use two of the swaps offered above to hedge its exchange rate risk.