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. USD Euro
$$\begin{array} { c c c c }
\text { Bid } & \text { Ask } & \text { Bid } & \text { Ask } \
8 \% & 8.1 \% & 6 \%& 6.1 \%
\end{array}$$ The firms external borrowing opportunities are
$\begin{array}{ccc}
& € \text { borrowing } & \$ \text { borrowing } \
\mathrm{A} & € 7 \% & \$ 8 \% \
\mathrm{~B} & € 6 \% & \$ 9 \%
\end{array}$
A)Firm A does 2 swaps with the swap bank,$ at bid and € at ask.Firm B does 2 swaps with the swap bank,$ at ask and € at bid.Firms A and B would each save 90bp and the swap bank would earn 20bp.
B)There is no mutually beneficial swap at these prices.
C)Firm A does 2 swaps with the swap bank,$ at ask and € at bid.Firm B does 2 swaps with the swap bank,$ at bid and € at ask.Firms A and B would each save 90bp and the swap bank would earn 20bp.
D)none of the options

Question

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. USD Euro
$$\begin{array} { c c c c } 
\text { Bid } & \text { Ask } & \text { Bid } & \text { Ask } \
8 \% & 8.1 \% & 6 \%& 6.1 \%
\end{array}$$ The firms external borrowing opportunities are
$\begin{array}{ccc} 
& € \text { borrowing } & \$ \text { borrowing } \
\mathrm{A} & € 7 \% & \$ 8 \% \
\mathrm{~B} & € 6 \% & \$ 9 \%
\end{array}$
A)Firm A does 2 swaps with the swap bank,$ at bid and € at ask.Firm B does 2 swaps with the swap bank,$ at ask and € at bid.Firms A and B would each save 90bp and the swap bank would earn 20bp.
B)There is no mutually beneficial swap at these prices.
C)Firm A does 2 swaps with the swap bank,$ at ask and € at bid.Firm B does 2 swaps with the swap bank,$ at bid and € at ask.Firms A and B would each save 90bp and the swap bank would earn 20bp.
D)none of the options

Quizplus · Accepted Answer

Firm A can borrow €1,000,000 at 7% in the euro market. It can swap €1,000,000 into $2,000,000 at 6% (bid rate) and then borrow $2,000,000 at 8% in the dollar market. The net cost of borrowing in dollars is 8% - 6% = 2%. Firm B can borrow $2,000,000 at 9% in the dollar market. It can swap $2,000,000 into €1,000,000 at 6.1% (ask rate) and then borrow €1,000,000 at 6% in the euro market. The net cost of borrowing in euros is 6.1% - 6% = 0.1%. Therefore, both firms can save money by using swaps.

A Is a US-Based MNC with AAA Credit; B Is an Italian Firm