Question

1. Dell Computers would like to borrow pounds, and Virgin Airlines wants to borrow dollars. Because Dell is better known in the United States, it can borrow on its own dollars at 7 percent and pounds at 9 percent, whereas Virgin can on its own borrow dollars at 8 percent and pounds at 8.5%

a. Suppose Dell wants to borrow £10 million for two years, Virgin wants to borrow $16 million for two years, and the current ($/£) exchange rate is $1.60. What swap transaction would accomplish this objective? Assume the counterparties would exchange principal and interest payments with no rate adjustments.

b. What savings are realized by Dell and Virgin?

c. Suppose, in fact, that Dell can borrow dollars at 7 percent and pounds at 9 percent, whereas Virgin can borrow dollars at 8.75 percent and pounds at 9.5 percent. What range of interest rates would make this swap attractive to both parties?

d. Based on the scenario in part (c), suppose Dell borrows dollars at 7 percent and Virgin borrows pounds at 9.5 percent. If the parties swap their current proceeds, with Dell paying 8.75 percent to Virgin for pounds and Virgin paying 7.75 percent to Dell for dollars, what are the cost savings to each party?

Answer 1