Question

A US company has a liability of €10 million in a fixed-rate bonds outstanding at 6%per annum. A German company has a $15 million in fixed-rate bonds outstanding at 5.2% per annum. The exchange rate is $1.5/€. Please provide details on the interest rates and currencies that the US company, German company and the swap dealer pays and receives under the swap contract that satisfies the following:•The same swap dealer is involved in this currency swap with the US company and the German company. •The US company’s net borrowing cost is 5.2% p.a. on $ and the German company’s net borrowing cost is 6.1% p.a. on €.•The swap dealer pays and receives $ at 5.2% p.a..

Answer 1

A) Swaps are derivative contracts. Under the currency swaps two partys exchange the liabilities payable in different currencies. The swap at the date of origin is done at the spot rate and usually the party's agree to use the same exchange rate at the end of the swap period to avoid transaction risk arising out of exchange rates.

During the tenure of the swap each party pays the interest only at the swapped prinicipal loan amount.

Given - SWAP ex.rate $1.5/ Euro. So Euro 10 million is swapped for USD 15 million loan.

USA Company pays interest in USD @ 5.2% on $15 million. That is an interest payment of $0.78 mn.

Germany company pays interest in Euro @ 6% on Euro 10 million. That is interest payment of Euro 0.6 mn.

SWAP dealer usually charges a commission to facilitate the transaction and does not own the risk of interest or principal repayments.

Neither USA company nor Germany company receives any interest payments on the SWAP transactions since only the obligation of interest payments are swapped.