Question

3 question (30%). Swap Comparative Advantage for Currency Swaps Given Mitsukoshi wants to borrow USD Tiffany & Co wants to borrow Yen USD 5.50% 6.75% Yen 4.75% 3.25% Tiffany & Co Mitsukoshi Ltd Required: a. Design a swap that will net a bank, acting as intermediary 0,1% (10 basis points) per annum. b. Make the swap equally attractive to the two companies and ensure that all foreign exchange rate is assumed by the ban Dr.oec. Andrejs Čirjevskis, profesors 09.01.2019

Answer 1

a)	Tiffany & Co has comparative advantage in USD of 6.75%-5.50% =	1.25%
	Mitsukoshi Ltd has comparative advantage in Yen of 4.75%-3.25% =	1.50%
	As the companies want to borrow in the other currency, a currency swap can be arranged by the bank where the net advantage will be 1.50%-1.25% =	2.75%
	Advantage to be shared by the parties after the intermediary bank's fee of 0.10% = 2.75%-0.10% =	2.65%
b)	The 2.65% can be shared in by Tiffany and Mitsukoshi in the
	ratio of 1.25:1.50 or 5:6.
	Share of Tiffany = 2.65%*5/11 =	1.20%
	Share of Mitsukoshi = 2.65%*6/11 =	1.45%
	Design of the Swap:
	Tiffany will borrow in USD and Mitsukoshi in Yen.
	Tiffany will pay 5.50% to the lender bank, get 6.70% from the intermediary bank and pay 4.75% to the intermediary bank, the net rate being -5.50%+6.70%-4.75% =	-3.55%
	Its saving by not directly borrowing in Yen = -3.55%-(-4.75%) =	1.20%
	Mitsukoshi will pay 3.25% to the lender bank, get 6.20% from the intermediary bank and pay 6.75% to the intermediary bank, the net rate being -3.25%+4.70%-6.75% =	-5.30%
	Its saving by not directly borrowing in USD = -5.30%-(-6.75%) =	1.45%