Question

Firm A is a U.S. MNC who wants to finance a pound denominated asset in England, and therefore wants to borrow 40 million pounds for 5 years. A can borrow pounds at 6% annual rate and borrow dollar at 2% annual rate.

Firm B is a British MNC who wants to finance a dollar denominated asset, and therefore wants to borrow 60 million dollars for 5 years. B can borrow dollars at 3% and borrow pounds at 4% annual rate.

Assume 1 pound=1.5 dollar.

Establish currency swap assuming a swap bank involved in the deal and its quotation as follows. What is the cost for A and B after the swap? Profits to swap bank and cost savings for A and B?

	bid	ask
Pound	4.0%	4.5%
Dollar	2.0%	2.5%

Answer 1

Currency Swap

Firm                                       Firm ‘A’ US MNC                             Firm ‘B’ British MNC

Amount Required            40 Million Pounds                            60 Million USD

Firm ‘A’ Require GBP 40 Million, i.e = 40 Million GBP *1.5USD, 60 Million USD

Therefore Loan Principal Amount is equal to Both the Firm, hence Currency Swap is Possible.

Timing	Firm “A” US MNC	Firm “B” British MNC
Now Borrow From their Local Bank and Finance to Respective asset in their domestic countries on behalf of Firm “A” and Firm “B”	60 Million USD	40 Million GBP
End of the First year Payment of Interest Exchange Interest	60 Million USD * 2.5% p.a 1500000 USD (6M *2.5/100) Firm “A” US will pay 2700000 USD (1,800,000*1.5 USD) to Firm “B” British MNC	40 Million GBP * 4.5% p.a 1800000 GBP (4M *4.5/100) Firm “B” will pay 1,500,000USD to Firm “A” U.S. Mnc.
Cost Saving for A & B	If there is no SWAP Interest will be 40 M GBP*6%*1.5 3,600,000 USD Saving = 3,600,000-2,700,000 =900000 USD	If there is no SWAP Interest will be 60 M USD*4%*1.5 2,400,000 USD Saving = 2,400,000-1,800,000 =600000USD