Mechanics of Swaps

[Hend Abuenein]

Hi

Referring to this question:

174.2. Company A can borrow Euros (EUR) at 5.0% fixed and U.S. Dollars (USD) at 4.0% fixed; Company A wants to borrow USD at a fixed interest rate. Company B, which is riskier, can borrow EUR at 6.2% fixed and USD at 4.8% fixed. The swap intermediary will provide a currency swap for a fee of 20 basis points (0.20%) per annum. If the designed swap is equally attractive to both companies, what is the total trade for Company B?

• a. Borrow at USD 4.8% and, with regard to swap, pay EUR at 5.0% and receive USD at 4.0%
• b. Borrow at USD 4.8% and, with regard to swap, pay EUR at 6.2% and receive USD at 4.0%
• c. Borrow at USD 4.8% and, with regard to swap, pay EUR at 6.1% and receive USD at 4.8%
• d. Borrow at USD 5.0% and, with regard to swap, pay EUR at 6.3% and receive USD at 5.0%

- Question doesn't say what company B needs/ wants?
- Question says A needs to borrow $ fixed when it is able to borrow it cheaper and less risky without the swap, so why would the swap be "equally attractive" to A?

I couldn't find the answer and explanation to this question, link to forum answers is broken.
Please help

 

[David Harper CFA FRM]

Hi Hend,

The Q&A are "down below" in the paid version of the forum. In this case, see
http://forum.bionicturtle.com/threads/l1-t3-174-interest-rate-swap-mechanics.4577/

Thanks, David

 

[Hend Abuenein]

Thank you

I wish you could add a banner or something that flickers and says : "Paid customers log in here" or something

There's a lot to read and search in.

BTW: I WAS logged in when I opened that question's page

 

[David Harper CFA FRM]

Hi Hend,

There is one login regardless, not sure how it could be made easier; i.e., you are either logged in or not, and paid status is handled automatically. In my opinion, a separate login would only complicate the interface.

I know the forum is a lot, that's why we collect the questions into PDFs in the study planner @ http://www.bionicturtle.com/my-account/study-planner
the forum format allows for follow-on conversation

... otherwise I can't discern a specific suggestion? But thanks, David

 

[Hend Abuenein]

Hi
The question right before that,
174.1

I thought I got it right answering C
But the given answer is B, although the explanation says

...Company B will 7.6%, which borrows fixed and is a 40 bps improvement over its 8.0% fixed alternative

.
Assuming the missing word in the underlining is "pay" , then the answer is C, not B. Right?
I'm confused about the "the swap trade only, not including the underlying borrowing?", what does it mean?

 

[David Harper CFA FRM]

Hi Hend,

Right, your (C) is correct in net terms, but this question just happens to ask (as you note) "with respect to the swap trade only." So, Company B, in order to achieve the so-called comparative advantage has two positions:

1. The "underyling borrowing" (where it has competitive advantage) at LIBOR + 2.0%;
2. Plus the swap trade to realize its goal of fixed-rate borrowing: Pay fixed 5.6% and receive LIBOR
   
   (to be sincere, I do like to deliberately remind that these hedges and transformations invariably involve two positions because it is very easy to think of them as only one position)

In net terms, Company B is paying 7.6% (as the receive and pay LIBORs cancel). So, it is just a matter of the question asking about the swap only. Your thinking to get to (C) is not incorrect.

Thanks for spotting the "pay" omission typo, i just fixed that!

Thanks, David