ABC, a US-Based Corporation Enters into a Currency Basis Swap

question 25

Multiple Choice

ABC, a US-based corporation enters into a currency basis swap with XYZ, a British company, in which the initial principal amounts are $200 million and £ 100 million. That is:
-At inception, there is an initial principal exchange in which ABC pays XYZ $200 million and receives £ 100 million.
-Subsequently, at each interest payment date ABC pays XYZ the GBP-Libor rate on £ 100 million, and receives the USD-Libor rate on $200 million.
-Fnally, at maturity, a re-exchange of principals occurs in which ABC pays XYZ £ 100 million in exchange for $200 million.
Suppose the spot exchange rate is $1.55 = £ 1 at the time of entering into the swap. Assume that ABC and XYZ both have AA credit ratings at this time and can access funds at Libor flat. Then, from a credit perspective,

• A) ABC is carrying more counterparty risk than XYZ.
• B) ABC is carrying less counterparty risk than XYZ.
• C) Both sides are carrying the same credit risk.
• D) Neither side is carrying any credit risk.

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