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Question:
a) Differentiate between interest and currency swaps.
b) You are the corporate treasurer of Quinnie International Inc. Your firm, rated as AAA, is able to raise capital in the Eurobond market with a fixed rate of 6 ½ % or at floating rate of LIBOR flat. However, Yuk International ltd, with a rating of BB is only able to receive the capital at fixed rate, 7 ½ % or a floating rate of LIBOR + ½ %.
Explain clearly how the companies can benefit of arbitrage possibilities, thus achieving cost savings on borrowing, by the help of an interest rate swap. You should take into account that, this transaction will be dealt through an intermediary and the latter will be claiming 1/8 % for its service. Make clear any assumptions you make.
c) Briefly write on the risks involved in such a swap transaction.
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