Repayments at maturity at current spot exchange rate

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Reference no: EM131934916

Ford's British subsidiary, Jaguar, needs to borrow £25 million in pound financing for 5 years.

It is cheaper however for Ford US, the parent, to borrow in $ rather than in pounds.

Ford can borrow dollars by issuing 5 year dollar denominated bonds at 5.25% interest. Ford could also sell an equivalent amount of 5 year pound denominated bonds at an interest cost of 6.00%. Assume that the spot quote for the pound is $1.3300.

Cadbury-Schweppes needs dollars to expand its investment in U.S. candy production. They are looking to raise a similar amount of money as Ford for five years. It is cheaper for Cadbury however to raise pound financing. Cadbury can borrow pounds for five years by issuing pound denominated bonds at 5.20% interest or borrow dollars by issuing U.S. dollar denominated bonds at 6.15%.

Have each company borrow at their advantaged rate and then work a currency swap deal where both firms agree to swap initial borrowings and principal repayments at maturity at the current spot exchange rate. Ford will pay a 5.20% fixed rate of interest to Cadbury and Cadbury will pay a 5.10% fixed rate of interest to Ford. Model the currency swap and show the cash flows and then show how many basis points each firm saves in interest cost as a result of the swap by showing the difference in the IRRs of Cadbury and Ford once the swap cash flows are included.

Reference no: EM131934916

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