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Question:
A U.S company has a liability of € 10 million in fixed rate loans outstanding at 6%. A German company has a $15 million Floating Rate Note outstanding at LIBOR. The exchange rate is $1.5/ €. The U.S Company enters into a plain vanilla currency swap with the dealer in which it pays LIBOR on $15 million and receives the swap rate of 6.0% on the € 10 million. The German company also enters into a plain vanilla currency swap with the same dealer, in which it pays a swap rate of 6.10% on the € 10 million and receives LIBOR on $15 million. One-year LIBOR is currently at 5.2%.
Required:
(a) Calculate each party's net borrowing cost
(b) Graphically represent the principal cash flows
(i) At initiation and (ii) At maturity of the contract.
(c) Calculate the first- year cash flows for the US company, German company and the dealer. (Assume annual settlement)
(d) Hubert Group based in France will need a loan in Swiss Francs in the near future. The company has a comparative advantage in raising Euros at a cheaper cost compared to raising Swiss Francs on the debt market. Furthermore, the company expects interest rates in the Euro currency zone and Switzerland to rise in the near future.
Based on the interest rate expectations, structure the currency swap so that it is beneficial for Hubert Group.
DIFFERENTIATE BETWEEN ALLOCATIVE EFFICIENCY AND PRICING EFFICIENCY
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