Question

Currency swaps can be used to convert one liability in one currency to a liability in another currency. They can also be used to convert an investment in one currency to an investment in another currency. Please consider firms A and B that could borrow at the following rates:

	Firm A	Firm B
US $ (floating)	LIBOR+0.5%	LIBOR+1%
Canadian Dollars (fixed)	5%	6.5%

Firm A has an advantage of 1.5% if borrowing in Canadian Dollars (at a fixed rate). The advantage of firm A when borrowing in US $ (at a floating rate) is only 0.5%. So, it is better for firm A to borrow in Canadian Dollars at a fixed rate. However, consider that firm A wants to borrow US $ (floating) and firm B wants to borrow Canadian Dollars (fixed). Please construct a swap that is equally attractive to both firms (please consider a bank acting as intermediary and requiring 0.5% spread).

Please show work and final answer

Answer 1

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