Consider a Fixed for Fixed Currency Swap

question 45

Multiple Choice

Consider a fixed for fixed currency swap.The Dow Corporation is a U.S.-based multinational.The Jones Corporation is a U.K.-based multinational.Dow wants to finance a £2 million expansion in Great Britain.Jones wants to finance a $4 million expansion in the U.S.The spot exchange rate is £1.00 = $2.00.Dow can borrow dollars at $10 percent and pounds sterling at 12 percent.Jones can borrow dollars at 9 percent and pounds sterling at 10 percent.Assuming that the swap bank is willing to take on exchange rate risk,but the other counterparties are not,which of the following swaps is mutually beneficial to each party and meets their financing needs?

• A)Dow should borrow $4 million in dollars externally at $10 percent; pay £11¾ percent in pounds to the swap bank on a notational principal of £2 million; receive $10 percent from the swap bank on a notational principal of $4 million.Jones,borrows £2 million pounds externally at £10 percent; pays $8¾ percent to the swap bank on a notational principal of $4 million and receives £10 percent in pounds from the swap bank on a notational principal of £2 million.
• B)Dow should borrow $4 million in dollars externally at $10 percent; pay £11½ percent in pounds to the swap bank on a notational principal of £2 million; receive $10 percent from the swap bank on a notational principal of $4 million.Jones,borrows £2 million pounds externally at £10 percent; pays $8½ percent to the swap bank on a notational principal of $4 million and receives £10 percent in pounds from the swap bank on a notational principal of £2 million.
• C)Dow should borrow $4 million in dollars externally at $10 percent; pay £11 percent in pounds to the swap bank on a notational principal of £2 million; receive $8 percent from the swap bank on a notational principal of $4 million.Jones,borrows £2 million pounds externally at £10 percent; pays $10 percent to the swap bank on a notational principal of $4 million and receives £11 percent in pounds from the swap bank on a notational principal of £2 million.
• D)There is no swap that is possible.

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Definitions:

Simultaneous Loose-Tight Properties

A concept in organizational management where certain aspects of a company are controlled tightly while others are allowed flexibility, promoting innovation and adherence to core values.

Strategic Opportunities

Prospects that align with an organization's strategic plan, offering potential for significant growth or advancement.

Subsystem

A division or component of a system that fulfills specific functions within the larger system's operation.

Contingent Operation

An operation or process that is dependent on certain conditions or events, which are usually uncertain or variable.