Question

Company A wishes to borrow U.S. dollars at a fixed rate of interest. Company B wishes to borrow sterling (British Pounds) at a fixed rate of interest. They have been quoted the following rates per annum (adjusted for differential tax effects): Sterling US Dollars Company A 11.0% 7.0% Company B 10.6% 6.2% Design a swap that will net a bank, acting as intermediary, 10 basis points per annum and that will produce a gain of 15 basis points per annum for each of the two companies. If Company B receives USD 6.2% from the financial institution, what is the Sterling rate that it must pay to the financial institution? (please enter your answers as percentages, for instance answer 9.0 to indicate 9.0%).

Answer 1

Total cost if Company A borrows USD and B borrows Sterling = 7%+10.6%

= 17.6%

Total cost under Swap i.e. when Company A borrows Sterling and B borrows USD

= 11% + 6.2%

= 17.2%

Total gain under swap = 0.4%

Charged by Intermediary = 0.10%

Shared by A and B = 0.30%

economic gain of each firm = 0.30%/2 = 0.15%

Net cost to B = Original Rate - Savings

= 10.6%-0.15% = 10.45%

Company B receives 6.2% from Intermediary, it must pay 10.45% to the institution