Company X Wants to Borrow $10,000,000 Floating for 5 Years;

Multiple Choice

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: $$\begin{array} { c c c } & \$ & £ \\& \text { Borrowing Cost } & \text { Borrowing Cost } \\\hline \text { Company X } & \$ 10 \% & £ 10.5 \% \\\text { Company Y } & \$ 12 \% & £ 13 \%\end{array}$$ A swap bank proposes the following interest-only swap: Company X will pay the swap bank annual payments on $10,000,000 at an interest rate of $9.80%; in exchange the swap bank will pay to company X interest payments on £5,000,000 at a fixed rate of 10.5%.Y will pay the swap bank interest payments on £5,000,000 at a fixed rate of 12.80% and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of 12%. If company X takes on the swap,what external actions should they engage in?

A) They should borrow $10,000,000 at $10%
B) They should borrow £5,000,000 at 10.50% interest-only for five years; translate pounds to dollars at the spot rate.
C) They should borrow £5,000,000 at £10.50% interest-only for five years; translate pounds to dollars at the spot rate; enter long position in a forward contract to buy £5,000,000 in five years.
D) None of the above