Question

Firm A is a U.S. MNC who wants to finance a pound denominated asset in England, and therefore wants to borrow 40 million pounds for 5 years. A can borrow pounds at 6% annual rate and borrow dollar at 2% annual rate.

Firm B is a British MNC who wants to finance a dollar denominated asset, and therefore wants to borrow 60 million dollars for 5 years. B can borrow dollars at 3% and borrow pounds at 4% annual rate.

Assume 1 pound=1.5 dollar.

a) What is QSD?

Answer 1

Answer:

QSD= 1%

QSD stands for Quality Spread Differential. It is used to calculate the difference between market interest rates that the two parties get while potentially entering into an interest rate swap. It is to identify the default risk of the company as well.

To understand QSD, we have to understand Quality Spread as well. Quality spread means the difference between the interest rate in the same currency. So, to calculate QSD, we identify the quality spread of 2 parties involved, and then by comparing the quality spread, we can get the QSD.

In the example, (Since exchange rate is 1 pound = 1.5 dollar, it would mean 40 million pounds equal to 60 million dollars)

Quality Spread:

For Pound borrowing: 6% - 4%: 2%

For Dollar borrowing: 3% - 2%: 1%

Quality Spread Differential (QSD): Pound Quality Spread - Dollar Quality Spread: 2% -1%: 1%