Consider Fixed-For-Fixed Currency Swap

question 11

Multiple Choice

Consider fixed-for-fixed currency swap. Firm A is a U.S.-based multinational. Firm B is a U.K.-based multinational. Firm A wants to finance a £2 million expansion in Great Britain. Firm B wants to finance a $4 million expansion in the U.S. The spot exchange rate is £1.00 = $2.00. Firm A can borrow dollars at $10% and pounds sterling at 12%. Firm B can borrow dollars at 9% and pounds sterling at 11%. Which of the following swaps is mutually beneficial to each party and meets their financing needs? Neither party should face exchange rate risk.

• A) There is no mutually beneficial swap that has neither party facing exchange rate risk.
• B) Firm A should borrow $4 million in dollars, pay 11% in pounds to Firm B, who in turn borrows 2 million pounds and pays 8% in dollars to A.
• C) Firm A should borrow $2 million in dollars, pay 11% in pounds to Firm B, who in turn borrows 4 million pounds and pays 8% in dollars to A.
• D) Firm A should borrow $4 million in dollars, pay 11% in pounds to Firm B, who in turn borrows 2 million pounds and pays 10% in dollars to A.

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Definitions:

Rental Price

The cost paid to rent a property or equipment for a specified period of time.

Market Equilibrium

A market scenario in which the equilibrium between demand and supply results in stable prices.

Incentive

Anything that offers rewards to people to change their behavior.

Quantity Demanded

The aggregate quantity of a product or service that buyers are prepared and capable of buying at a certain price.