Exam 14: Interest Rate and Currency Swaps

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. The IRP 1-year and 2-year forward exchange rates are -Explain how firm A could use two of the swaps offered above to hedge its exchange rate risk.

The term interest rate swap

Examples of "single-currency interest rate swap" and "cross-currency interest rate swap" are:

Consider a fixed for fixed currency swap.The Dow Corporation is a U.S.-based multinational.The Jones Corporation is a U.K.-based multinational.Dow wants to finance a £2 million expansion in Great Britain.Jones wants to finance a $4 million expansion in the U.S.The spot exchange rate is £1.00 = $2.00.Dow can borrow dollars at $10% and pounds sterling at 12%.Jones can borrow dollars at 9% and pounds sterling at 10%.Assuming that the swap bank is willing to take on exchange rate risk,but the other counterparties are not,which of the following swaps is mutually beneficial to each party and meets their financing needs?

Compute the payments due in the second year on a three-year AMORTIZING swap from company B to company A)Company A and company B both want to borrow £1,000,000 for three years.A wants to borrow floating and B wants to borrow fixed.A and B agree to split the QSD.

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: 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?

What would be the interest rate?

In the problem just previous,company X

What would be the interest rate?

FOR YOUR SWAP (the one you have shown above)how would the swap bank quote the swap against prime? (Hint: they are quoting a bid-ask spread against "flat" prime.)

A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit.Firm A wants to borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year.The spot exchange rate is $2.00 = €1.00,a swap bank makes the following quotes for 1-year swaps and AAA-rated firms against USD LIBOR: The firm's external borrowing opportunities are:

With regard to a swap bank acting as a dealer in swap transactions,interest rate risk refers to

Which combination of the following represent the risks that a swap dealer confronts? (i)- interest rate risk (ii)- basis risk (iii)- exchange rate risk (iv)- political risk (v)- sovereign risk

Company X wants to borrow $10,000,000 for 5 years; company Y wants to borrow £5,000,000 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 shown below: A swap bank proposes the following interest only swap: X will pay the swap bank annual payments on $10,000,000 with the coupon 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%. What is the value of this swap to the swap bank?

Compute the payments due in the FIRST year on a three-year AMORTIZING swap from company B to company A)Company A and company B both want to borrow £1,000,000 for three years.A wants to borrow floating and B wants to borrow fixed.A and B agree to split the QSD.

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown below: A swap bank proposes the following interest only swap: Y will pay the swap bank annual payments on $10,000,000 with a fixed rate of 9.90%.In exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR - 0.15%; What is the value of this swap to company Y?

An interest-only currency swap has a remaining life of 18 months.It involves exchanging interest at 14% on £20 million for interest at 10% on $14 million once a year.The term structure of interest rates is currently flat in both the U.S.and in the U.K.If the swap were negotiated today the interest rates exchanged would be $8% and £11%.All rates were quoted with annual compounding.The current exchange rate is $1.95 = £1.What is the value of the swap to the party paying dollars?

Suppose ABC Investment Banker,Ltd.is quoting swap rates as follows: 7.50 - 7.85 annually against six-month dollar LIBOR for dollars,and 11.00 - 11.30 percent annually against six-month dollar LIBOR for British pound sterling.ABC would enter into a $/£ currency swap in which: Refer To: 14-21

Amortizing currency swaps

Explain how firm A could use the forward exchange markets to redenominate a 2-year $60m 6% USD loan into a 2-year pound denominated loan.