《跨國(guó)公司財(cái)務(wù)管理基礎(chǔ)》教師手冊(cè)與PPTch-2

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CHAPTER8:SWAPSANDINTERESTRATEDERIVATIVES

CHAPTER8

SWAPSANDINTERESTRATEDERIVATIVES

ThischapterexaminesseveralspecialfinancingvehiclesthatMNCscanusetofundtheirforeigninvestments.Thesevehiclesincludeinterestrateandcurrencyswaps,structurednotes,interestrateforwardandfuturescontracts,internationalleasing,andLDCdebt-equityswaps.EachofthesevehiclespresentsopportunitiestotheMNCtoachieveoneormoreofthefollowinggoals:reducethecostoffunds,cuttaxes,andreducepoliticaland/orforeignexchangerisk.Theseopportunitiestocreatevaluearisefromvariousmarketimperfections,whichIdiscuss.

Interestandcurrencyswapsarefinancialtransactionsinwhichtwocounterpartiesagreetoexchangestreamsofpaymentsovertime.Ineffect,aswapisapackageofforwardcontracts.Forswapstoprovidearealeconomicbenefittobothparties,abarriergenerallymustexisttopreventarbitragefromfunctioningfully.Thisimpedimentmusttaketheformoflegalrestrictionsonspotandforwardforeignexchangetransactions,differentperceptionsbyinvestorsofriskandcreditworthinessofthetwoparties,appealoracceptabilityofoneborrowertoacertainclassofinvestor,taxdifferentials,andsoforth.

Structurednotesareinterest-bearingsecuritieswhoseinterestpaymentsaredeterminedbyreferencetoaformulasetinadvanceandadjustedonspecifiedresetdates.Theformulacanbetiedtoavarietyofdifferentfactors,suchasLIBOR,exchangerates,orcommodityprices.Sometimestheformulaincludesmultiplefactors,suchasthedifferencebetweenthree-monthdollarLIBORandthree-monthSwissfrancLIBOR.Thecommoncharacteristicisoneormoreembeddedderivativeelements,suchasswaps,forwards,oroptions.Structurednotescanbeusedtoreduceriskorbetonone’sforecastoffutureinterestrates,exchangerates,andsoon.

Inadditiontoswapsandstructurednotes,companiescanuseavarietyofforwardandfuturescontractstomanagetheirinterestrateexpenseandrisk.Thesecontractsincludeforwardforwards,forwardrateagreements,andEurodollarfutures.Theseallowcompaniestolockininterestratesonfutureloansanddeposits.Aforwardforwardisacontractthatfixesaninterestratetodayonafutureloanordeposit.Thecontractspecifiestheinterestrate,theprincipalamountofthefuturedepositorloan,andthestartandendingdatesofthefutureinterestrateperiod.

Inrecentyears,forwardforwardshavebeenlargelydisplacedbyforwardrateagreements(FRAs).AnFRAisacash-settled,over-the-counterforwardcontractthatallowsacompanytofixaninterestratetobeappliedtoaspecifiedfutureinterestperiodonanotionalprincipalamount.Itisanalogoustoaforwardforeigncurrencycontractbutinsteadofexchangingcurrencies,thepartiestoanFRAagreetoexchangeinterestpayments.

2INSTRUCTORSMANUAL:FOUNDATIONSOFMULTNATIONALFINANCIALMANAGEMENT,6THED.

AEurodollarfutureisacash-settledfuturescontractonathree-month,$1,000,000EurodollardepositthatpaysLIBOR.EurodollarfuturescontractsaretradedonvariousorganizedexchangesforMarch,June,September,andDecemberdelivery.Contractsaretradedouttothreeyears,withahighdegreeofliquidityouttotwoyears.EurodollarfuturesactlikeFRAsinthattheyhelplockinafutureinterestrateandaresettledincash.ButunlikeFRAs,theyaremarkedtomarketdaily(asincurrencyfutures,thismeansthatgainsandlossesaresettledincasheachday).

Cross-borderorinternationalleasingcanbeusedtobothdeferandavoidtax.ItcanalsobeusedtosafeguardtheassetsofanMNC’sforeignaffiliatesandavoidcurrencycontrols.

Underadebt-equityprogram,afirmbuysacountry’sdollardebtonthesecondaryloanmarketatadiscountandswapsitintolocalequity.Suchswapscreatethepossibilityofcheapfinancingforexpandingplantandretiringlocaldebtinhard-pressedLDCs.

SUGGESTEDANSWERSTOCHAPTER8QUESTIONS

1.Whatisaninterestrateswap?Whatisthedifferencebetweenabasisswapandacouponswap?

ANSWER.Aninterestrateswapisanagreementbetweentwopartiestoexchangeinterestpaymentsinthesamecurrencyforaspecificmaturityonanagreed-onnotionalamount.Notionalreferstothetheoreticalprincipalunderlyingtheswap.Inthecouponswap,onepartypaysafixedratecalculatedatthetimeoftradeasaspreadtoaparticularTreasurybond,whiletheothersidepaysafloatingratethatresetsperiodicallythroughoutthelifeofthedealagainstadesignatedindex.Inabasisswap,afloating-rateliabilitytiedtoonereferencerate,say,LIBOR,isexchangedforafloating-rateliabilitywithanotherreferencerate,say,90-dayTreasurybills.Thus,couponswapsconvertfixed-ratedebtintofloating-ratedebt(orviceversa),whereasthebasisswapconvertsonetypeoffloating-ratedebtintoanothertypeoffloating-ratedebt.

2.Whatisacurrencyswap?

ANSWER.Acurrencyswapinvolvestheexchangeofprincipalplusinterestpaymentsinonecurrencyforequivalentpaymentsinanothercurrency.

3.Commentonthefollowingstatement.“Foronepartytoaswaptobenefit,theotherpartymustlose.”

ANSWER.Giventhatbothpartiestotheswapfreelyenterintotheswaptransaction,bothmustperceivebenefits.Thetax,financialmarket,andregulatorysystemarbitragebenefitsassociatedwithswapsaresharedbybothparties.

4.TheSwissCentralBankbanstheuseofSwissfrancsforEurobondissues.ExplainhowcurrencyswapscanbeusedtoenableforeignborrowerswhowanttoraiseSwissfrancsthroughabondissueoutsideofSwitzerlandtogetaroundthisban.

ANSWER.ForeignborrowerscanissueEurodollarbondsandthenswaptheproceedsforSwissfrancs.Inthisway,theycanraiseSwissfrancswithoutviolatingthebanonissuingSwissfrancEurobonds.

CHAPTER8:SWAPSANDINTERESTRATEDERIVATIVES3

5.ExplainhowIBMcanuseaforwardrateagreementtolockinthecostofaone-year,$25millionloantobetakenoutinsixmonths.Alternatively,explainhowIBMcanlockintheinterestrateonthisloanbyusingEurodollarfuturescontracts.Whatisthemajordifference

betweenusingtheFRAandthefuturescontracttohedgeIBM’sinterestraterisk?

ANSWER.Tolockintherateonaone-year,$25millionloantobetakenoutinsixmonths,IBMcouldbuya“6x12”FRAonLIBORforanotionalprincipalof$25million.Thatis,IBMentersintoasix-monthforwardcontracton12-monthLIBOR.Alternatively,IBMcanlockintheinterestrateonthisloanbyselling25$1million6-monthfuturescontracts.However,thistransactionwillonlyprotectIBMforthefirstthreemonthsofitsloan.Tohedgetheremainingninemonthsoffutureloan,IBMwouldsell25$1million9-month,12-month,and15-monthfuturescontracts.ThemostimportantdifferencebetweenusingtheFRAandthefuturescontractisthatthelatterismarkedtomarketdaily.Inaddition,theFRAinvolvesenteringintojustonecontractforthe12-monthloan,whereasusingthefuturescontracttohedgeIBM’sinterestrateriskinvolvesenteringintofourseparatethree-monthfuturescontracts.

ADDITIONALCHAPTER8QUESTIONSANDANSWERS1.Whatfactorsunderlietheeconomicbenefitsofswaps?

ANSWER.Toprovideeconomicbenefits,swapsmustallowthetransactingpartiestoengageinsomeformoftax,regulatorysystem,orfinancialmarketarbitrage.Thus,underlyingtheeconomicbenefitsofswapsarebarriersthatpreventotherformsofarbitragefromfunctioningfully.Thisimpedimentmusttaketheformoflegalrestrictionsonspotandforwardforeignexchangetransactions,differentperceptionsbyinvestorsofriskandcreditworthinessofthetwoparties,appealoracceptabilityofoneborrowertoacertainclassofinvestor,taxdifferentials,andsoforth.Iftheworldcapitalmarketwerefullyintegrated,theincentivetoswapwouldbereducedbecausefewerarbitrageopportunitieswouldexist.

2.Commentonthefollowingstatement.“Duringtheperiod1987-1989,Japanesecompaniesissuedsome$115billionofbondswithwarrantsattached.Nearlyallwereissuedindollars.Thedollarbondsusuallycarriedcouponsof4%orless;bythetimetheJapanesecompaniesswappedthatexposureintoyen(whoseinterestratewasasmuchasfivepercentagepointslowerthanthedollar's),theircostofcapitalwaszeroornegative.”

ANSWER.ThisstatementassumesthatthewarrantsontheJapanesebonds,whicharelong-datedcalloptions,arecostlessfortheJapanesefirmstoissue.Theyarenot.Duringthisperiod,Japanesestockpricesrosedramatically.ThenetresultwasthatJapanesefirmsdidnotissuecheapdebt;instead,theyissuedexpensiveequity.Thatis,theyissuedequityattheexercisepriceonthewarrants,whichwastypicallyfarbelowthepriceatwhichtheycouldhavesoldnewstockinthemarketplace.

3.ExplainhowCiscoSystemscanusearbitragetocreateaforwardforwardtofixtheinterestrateonathree-month$10millionloantobetakenoutinninemonths.TheloanwillbepricedoffLIBOR.

ANSWER.Ciscocanlockinathree-monthrateona$10millionloantobetakenoutinninemonthsbybuyingaforwardforwardorbycreatingitsownthrougharbitrage.Specifically,Ciscocanderiveanine-monthforwardrateonLIBOR3bysimultaneouslylendingthepresentvalueof$10millionforninemonthsandborrowingthatsameamountofmoneyfor12months.

4INSTRUCTORSMANUAL:FOUNDATIONSOFMULTNATIONALFINANCIALMANAGEMENT,6THED.

4.Whydogovernmentsprovidesubsidizedfinancingforsomeinvestments?

ANSWER.Governmentsusesubsidizedfinancingtoencourageprogramsandactivitiesthataredeemedtobeworthy.Forexample,governmentsprovidesubsidizedtradefinancingtoboostexportsandlow-costfinancingtoprojectsexpectedtocreatejobsinregionswithhighunemployment.Often,thesesubsidiesoffsetregulatoryandothercoststhatareimposedoncompaniesbythesamegovernments.

SUGGESTEDSOLUTIONSTOCHAPTER8PROBLEMS

1.DellInc.wantstoborrowpounds,andVirginAirlineswantstoborrowdollars.BecauseDellisbetterknownintheU.S.,itcanborrowonitsowndollarsat7%andpoundsat9%,whereasVirgincanborrowdollarsat8%andpoundsat8.5%

1.a.SupposeDellwantstoborrow￡10millionfortwoyears,Virginwantstoborrow$16million

fortwoyears,andthecurrent($/￡)exchangerateis$1.60.Whatswaptransactionwouldaccomplishthisobjective?Assumethecounterpartieswouldexchangeprincipalandinterestpaymentswithnorateadjustments.

ANSWER.Virginwouldborrow￡10millionfortwoyearsandDellwouldborrow$16millionfortwoyears.Thetwocompanieswouldthenswaptheirproceedsandpaymentstreams.

1.b.WhatsavingsarerealizedbyDellandVirgin?

ANSWER.Assumingnointerestrateadjustments,Dellwouldpay8.5%onthe￡10millionandVirginwouldpay7%onits$16million.Giventhatitsalternativewastoborrowpoundsat9%,Dellwouldsave0.5%onitsborrowings,oranannualsavingsof￡50,000.Similarly,Virginwindsuppayinganinterestrateof7%insteadof8%onitsdollarborrowings,savingit1%or$160,000annually.

1.c.Suppose,infact,thatDellcanborrowdollarsat7%andpoundsat9%,whereasVirgincan

borrowdollarsat8.75%andpoundsat9.5%.Whatrangeofinterestrateswouldmakethisswapattractivetobothparties?

ANSWER.Ignoringcreditriskdifferences,VirginwouldhavetoprovideDellwithapoundrateoflessthan9%.GiventhatVirginhastoborrowthepoundsat9.5%,itwouldhavetosaveatleast0.5%onitsdollarborrowingfromDelltomaketheswapworthwhile.IfDellborrowspoundsfromVirginat9%-x,VirginwouldhavetoborrowdollarsfromDellat8.75%-(0.5%+x)tocoverthe(0.5%+x)differencebetweentheinterestrateatwhichitwasborrowingpoundsandtheinterestrateatwhichitwaslendingthosepoundstoDell.

1.d.Basedonthescenarioin1.c,supposeDellborrowsdollarsat7%andVirginborrowspounds

at9.5%.Ifthepartiesswaptheircurrentproceeds,withDellpaying8.75%toVirginforpoundsandVirginpaying7.75%toDellfordollars,whatarethecostsavingstoeachparty?

ANSWER.Underthisscenario,Dellsaves0.25%onitspoundborrowingsandearns0.75%onthedollarsitswapswithVirgin,foratotalbenefitof1%annually.Virginloses0.75%onthepoundsitswapswithDellandsaves1%onthedollarsitreceivesfromDell,foranetsavingsof0.25%annually.

CHAPTER8:SWAPSANDINTERESTRATEDERIVATIVES5

2.InMay1988,WaltDisneyProductionssoldtoJapaneseinvestorsa20-yearstreamofprojectedyenroyaltiesfromTokyoDisneyland.Thepresentvalueofthatstreamofroyalties,discountedat6%(thereturnrequiredbytheJapaneseinvestors),was￥93billion.Disneytooktheyenproceeds,convertedthemtodollars,andinvestedthedollarsinbondsyielding10%.AccordingtoDisney’sCFO,“Ineffect,wegotmoneyata6%discountrate,reinvesteditat10%,andhedgedourroyaltystreamagainstyenfluctuations–allinonetransaction.”

2.a.Atthetimeofthesale,theexchangeratewas￥124=$1.WhatdollaramountdidDisney

realizefromthesaleofitsyenproceeds?

ANSWER.Disneyrealized93,000,000,000/124=$750,000,000fromthesaleofitsfutureyenproceeds.

2.b.DemonstratetheequivalencebetweenDisney’stransactionandacurrencyswap.(Hint:

adiagramwouldhelp)

ANSWER.Inacurrency/interestrateswap,onepartytradesastreamofpaymentsinonecurrency,atoneinterestrate,forastreamofpaymentsinasecondcurrency,atasecondinterestrate.Disney’sstreamofyenroyaltiescanbetreatedasayenbond,whichittradedforadollarbond,withdollarpayments.TheonlydifferencebetweentheDisneyswapandatraditionalswapisthatthelatterusuallyinvolvecashoutflowswhereastheDisneyswapinvolvescashinflows.

2.c.DidDisneyachievetheequivalentofafreelunchthroughitstransaction?

ANSWER.TheCFOiscommittingtheeconomist’sunpardonablesin:Heiscomparingappleswithoranges,inthiscase,a6%yeninterestratewitha10%dollarinterestrate.TheIFEtellsusthatthemostlikelyreasonthattheyeninterestrateis4percentagepointslessthantheequivalentdollarinterestrateisbecausethemarketexpectsthedollartodepreciatebyabout4%annuallyagainsttheyen.

3.SupposeIBMwouldliketoborrowfixed-rateyen,whereasKoreaDevelopmentBank(KDB)wouldliketoborrowfloating-ratedollars.IBMcanborrowfixed-rateyenat4.5%orfloating-ratedollarsatLIBOR+0.25%.KDBcanborrowfixed-rateyenat4.9%orfloating-ratedollarsatLIBOR+0.8%.

3.a.WhatistherangeofpossiblecostsavingsthatIBMcanrealizethroughaninterest

rate/currencyswapwithKDB?

ANSWER.Thecosttoeachpartyofaccessingeitherthefixed-rateyenorthefloating-ratedollarmarketforanewdebtissueisasfollows:

Borrower

KoreaDevelopmentBankIBM

Difference

Fixed-RateYenAvailable

4.9%

4.5%

0.4%

Floating-RateDollarsAvailable

LIBOR+0.80%

LIBOR+0.25%0.55%

Giventheratedifferencesbetweenthemarkets,thetwopartiescanachieveacombined15-basis-pointsavingsthroughIBMborrowingfloating-ratedollarsatLIBOR+0.25%andKDBborrowingfixed-rateyenat4.9%andthenswappingtheproceeds.IBMwouldborrowfixed-rateyenat4.35%ifthesesavingswerepassedalongintheswap.ThiscouldbeachievedbyIBMprovidingfloating-ratedollarstoKBDatLIBOR+0.25%,savingKDB0.55%,whichthenpassedthesesavingsalongtoIBMbyswappingthefixed-rateyenat4.9%-0.55%=4.35%.Thus,thepotentialsavingstoIBMrangefrom0%to0.15%.

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3.b.Assuminganotionalprincipalequivalentto$125millionandacurrentexchangerateof

￥105/$,whatdothesepossiblecostsavingstranslateintoinyenterms?

ANSWER.Atacurrentexchangerateof￥105/$,IBM’sborrowingwouldequal￥13,125,000,000(125,000,000*105).A0.15%savingsonthatamountwouldtranslateinto￥19,687,500perannum(￥13,125,000,000*0.0015).

3.c.RedopartsaandbassumingthepartiesuseBankofAmerica,whichcharges8basispoints

toarrangetheswap.

ANSWER.Inthiscase,thepotentialsavingsfromaswapnetoutto7basispoints.IfIBMrealizesallthesesavings,itsborrowingcostwouldbeloweredto4.43%(4.5%-0.07%).The7-basis-pointsavingwouldtranslateintoanannualsavingof￥9,187,500(￥13,125,000,000*0.0007).

4.Attimet,3Mborrows￥12.8billionataninterestrateof1.2%,paidsemiannually,foraperiodoftwoyears.Itthenentersintoatwo-yearyen/dollarswapwithBankersTrust(BT)onanotionalprincipalamountof$100million(￥12.8billionatthecurrentspotrate).Everysixmonths,3MpaysBTU.S.dollarLIBOR6,whileBTmakespaymentsto3Mof1.3%annuallyinyen.Atmaturity,BTand3Mreversethenotionalprincipals.

4.a.AssumethatLIBOR6(annualized)andthe￥/$exchangerateevolveasfollows.Calculatethe

netdollaramountthat3MpaystoBT(-)orreceivesfromBT(+)eachsix-monthperiod.

Time(months)LIBOR6￥/$(spot)

t5.7%128

t+65.4%132

t+125.3%137

t+185.9%131

t+245.8%123

ANSWER.Thesemiannualreceipts,payments,andnetreceipts(payments)arecomputedasfollows:

Net$Receipt(+)/

Time(months)

t

LIBOR6

5.7%

￥/$(spot)

128

Receipt

Payment

Payment(-)

t+6

5.4%

132

$630,303

$2,700,000

$2,069,697

t+12

5.3%

137

$607,299

$2,650,000

$2,042,701

t+18

5.9%

131

$635,115

$2,950,000

$2,314,885

t+24

5.8%

123

$676,423

$2,900,000

$2,223,577

Thereisnopaymentorreceiptattimet.Thesemiannualpaymentiscalculatedas$100,000,000*LIBOR6/2.Thesemiannualreceiptiscalculatedas12,800,000,000*0.013/2*1/S,whereSisthecurrentspotrate(￥/$).

CHAPTER8:SWAPSANDINTERESTRATEDERIVATIVES7

4.b.Whatistheall-indollarcostof3M’sloan?

ANSWER.Thenetpaymentsmadesemiannuallyby3Mareshowninthetablebelow.ThenetpaymentiscomputedastheLIBOR6paymentmadetoBTlessthedollarvalueofthe0.05%semiannualdifferencebetweentheyeninterestreceivedandtheyeninterestpaid(showninthecolumnlabeled“Receipt.”)

Time(months)LIBOR6￥/$(spot)ReceiptPaymentNet$Payment

t5.7%128-$100,000,000

t+65.4%132$48,485$2,700,000$2,651,515

t+125.3%137$46,715$2,650,000$2,603,285

t+185.9%131$48,855$2,950,000$2,901,145

t+245.8%123$52,033$2,900,000$102,847,967

IRR2.75%

IRRAnnualized5.50%

4.c.Suppose3Mdecidesatt+18touseasix-monthforwardcontracttohedgethet+24receipt

ofyenfromBT.Six-monthinterestrates(annualized)att+18are5.9%indollarsand2.1%inyen.Withthishedgeinplace,whatfixeddollaramountwould3Mhavepaid(received)attimet+24?Howdoesthisamountcomparetothet+24netpaymentcomputedinparta?

ANSWER.Giventheinterestratespresentedintheproblem,wecanuseinterestrateparitytocomputethe6-monthforwardrateattimet+18as￥128.58/$:

0.021

20.059

2

f=131x

180

1+

1+

=?28.58

3Mwillpayout$2.9million(0.059/2*$100,000,000)andreceive$647,056(0.013/2*12,800,000*1/128.58).Thelatterfigureiscalculatedbyconvertingitsyenreceiptintodollarsattheforwardrateof￥128.58/$.3M’snetpaymentequals$2,252,944($2,900,000-$647,056).Thisamountis$29,367morethanthenetpaymentof$2,223,577itwouldhavemadeotherwise.

4.d.Doesitmakesensefor3MtohedgeitsreceiptofyenfromBT?Explain.

ANSWER.No.Asitnowstands,3Mreceivesyenandpaysoutyen,resultinginazeronetexposureontheswap(asidefromthenet0.05%semiannualyenreceipt).Hedgingwouldexpose3Mtocurrencyriskandnegatethepurposeofthecross-currencyswap,whichistoallow3Mtoengageinarbitragewhilebeingshieldedfromcurrencyrisk.

5.SupposeLIBOR3is7.93%andLIBOR6is8.11%.WhatistheforwardforwardrateforaLIBOR3deposittobeplacedinthreemonths?

ANSWER.Througharbitrage,thefuturevalueinsixmonthsof$1investedtodaymustbethesamewhetherweinvestatLIBOR3todayandenterintoaforwardforwardforthefollowingthreemonthsorinvestatLIBOR6today.Thatis,

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(1+LIBOR3/4)(1+r/4)=1+LIBOR6/2

whererequalstheforwardforwardrateforaLIBOR3deposittobeplacedinthreemonths.Substitutingnumbersfromtheproblem,wehave1.0198(1+r/4)=1.04055.Solvingthisequationyieldsr=8.13%.

6.SupposethatSkandinaviskaEnsildenBanken(SEB),theSwedishbank,fundsitselfwiththree-monthEurodollartimedepositsatLIBOR.AssumethatAlfaLavalcomestoSEBseekingaone-year,fixed-rateloanof$10million,withinteresttobepaidquarterly.Atthetimeoftheloandisbursement,SEBraisesthree-monthfundsat5.75%,buthastorolloverthisfundinginthreesuccessivequarters.Ifitdoesnotlockinafundingrateandinterestratesrise,theloancouldprovetobeunprofitable.Thethreequarterlyre-fundingdatesfallshortlybeforethenextthreeEurodollarfuturescontractexpirationsinMarch,June,andSeptember.

6.a.Atthetimetheloanismade,thepriceofeachcontractis94.12,93.95,and93.80.Showhow

SEBcanuseEurodollarfuturescontractstolockinitscostoffundsfortheyear.WhatisSEB’shedgedcostoffundsfortheyear?

ANSWER.Theformulaforthelocked-inLIBOR,r,givenapricePofaEurodollarfuturescontractisr=100-P.Usingthisformula,thesolutionrforeachofthecontractsis5.82%,6.05%,and6.2%.SoSEBcanlockinacostforits$10millionloanequalto$10,000,000*(1+0.0575/4)(1+0.0582/4)(1+0.0605)(1+0.062/4)=$10,608,927,whichisequivalenttoaone-yearfixedinterestrateof6.09%.Effectively,thisprocedurerollsovertheprincipalandcumulativeinterestpaymenteachquarteruntilitispaidoffinalumpsumattheendofthefourthquarter.

6.b.SupposethatthesettlementpricesoftheMarch,June,andSeptembercontractsare,

respectively,92.98,92.80,and92.66.WhatwouldhavebeenSEB’sunhedgedcostoffundingtheloantoAlfaLaval?

ANSWER.Wecansolvethisproblembyusingtheinsightthatatthetimeofsettlement,arbitragewillensurethatthesettlementpriceforaEurodollarfuturescontractwillbevirtuallyidenticaltotheactualLIBORonthatdate.Giventhestatedpricesatsettlement,actualLIBORoneachrolloverdatewas7.02%,7.2%,and7.34%.Basedonthesefigures,theunhedgedcostoftheloanis$10,000,000*(1+0.0575/4)(1+0.0702/4)(1+0.072/4)(1+0.0734/4)=$10,700,379.Thisisequivalenttoanannualrateof7.00%,or91basispointsmorethanthehedgedcostoftheloan.

ADDITIONALCHAPTER8PROBLEMSANDSOLUTIONS

1.CompanyA,alow-ratedfirm,desiresafixed-rate,long-termloan.CompanyAcurrentlyhasaccesstofloating-ratefundsatamarginof1.5%overLIBOR.Itsdirectborrowingcostis13%inthefixed-ratebondmarket.Incontrast,CompanyB,whichprefersafloating-rateloan,hasaccesstofixed-ratefundsintheEurodollarbondmarketat11%andfloating-ratefundsatLIBOR+0.50%.

6.a.HowcanAandBuseaswaptoadvantage?

ANSWER.Basedonthenumberspresented,thereisananomalybetweenthetwomarkets:Onejudgesthatthedifferenceincreditqualitybetweenthetwofirmsisworth200basispoints,whereastheotherdeterminesthatthisdifferenceisworthonly100basispoints.Thepartiescansharebetweenthemselvesthedifferenceof100basispointsbyengaginginacurrencyswap.ThistransactionwouldinvolveAborrowingfloating-ratefundsandBborrowingfixed-ratefundsandthenswappingtheproceeds.

CHAPTER8:SWAPSANDINTERESTRATEDERIVATIVES9

6.b.Supposetheysplitthecostsavings.HowmuchwouldApayforitsfixed-ratefunds?How

muchwouldBpayforitsfloating-ratefunds?

ANSWER.Iftheysplitthecostsavings,theresultingcoststothetwopartieswouldbe12.5%forAandLIBORforB,calculatedasfollows:

Party

NormalFundingCost

CostAfterSwap

Difference

CounterpartyA

13.00%

12.50%

0.50%

CounterpartyB

LIBOR+0.5%

LIBOR

0.50%1.00%

2.SquareCorp.hasnottappedtheSwiss-francpublicdebtmarketbecauseofconcernaboutalikelyappreciationofthatcurrencyandonlywishestobeafloating-ratedollarborrower,whichitcanbeatLIBOR+3/8%.CircleCorp.hasastrongpreferenceforfixed-rateSwiss-francdebt,butitmustpay0.5%morethanthe51/4%couponthatSquareCorp.’snoteswouldcarry.CircleCorp.,however,canobtainEurodollarsatLIBORflat(azeromargin).WhatistherangeofpossiblecostsavingstoSquarefromengaginginacurrencyswapwithCircle?

ANSWER.SquareCorp.canborrowfixed-rateSwissfrancsat5.25%andfloating-ratedollarsatLIBOR+3/8%.MeanwhileCircleCorp.canborrowfixed-rateSwissfrancsat5.75%andfloating-ratedollarsatLIBORflat.Thelogicalsetoftransactionsunderthesecircumstanceswouldbe(1)Squareborrowsfixed-ratefrancs,(2)Circleborrowsfloating-ratedollars,and(3)thecompaniesthenswapthepaymentstreams.ThemaximumbenefittoSquareariseswhenitprovidesfixed-ratefrancstoCircleat5.75%(Circleisnoworseoffunderthisscenario)andreceivesfloating-ratedollarsatLIBOR,whichisCircle'scostoffunds(Circleisagainnoworseoffunderthisscenario).ThisswapwillcutSquare’scostoffundstoLIBOR-0.5%,whic