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?
A)They should borrow $10,000,000 at $10%.
B)They should borrow £5,000,000 at 10.50% interest-only for five years; translate pounds to dollars at the spot rate.
C)They should borrow £5,000,000 at £10.50% interest-only for five years; translate pounds to dollars at the spot rate; enter long position in a forward contract to buy £5,000,000 in five years.
D)None of the above

Question

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?
A)They should borrow $10,000,000 at $10%. 
B)They should borrow £5,000,000 at 10.50% interest-only for five years; translate pounds to dollars at the spot rate. 
C)They should borrow £5,000,000 at £10.50% interest-only for five years; translate pounds to dollars at the spot rate; enter long position in a forward contract to buy £5,000,000 in five years. 
D)None of the above

Quizplus · Accepted Answer

Company X wants to borrow $10,000,000 floating for 5 years but instead, it can swap it with fixed payments on £5,000,000 at a fixed rate of 10.5% with the swap bank. Hence, Company X should borrow £5,000,000 at £10.50% interest-only for five years, translate pounds to dollars at the spot rate, and enter a long position in a forward contract to buy £5,000,000 in five years to eliminate the currency risk.

Company X Wants to Borrow $10,000,000 Floating for 5 Years;