Question

1. Consider counterparties AA and BB. AA desires n-year floating rate on US dollars while BB desires fixed rate on pound sterling. The following borrowing costs are available to the parties:

                                                Floating rate ($)                    Fixed rate (£)

            AA                               7.75%                                    12.75%

            BB                               8.10%                                    13.55%

A swap dealer proposes BP-USD currency swap under which the dealer stands to pay a fixed rate of 13.20% (on BP) against a floating rate of 8% (on USD) or receive a 13.30% fixed against floating rate of 8%.

Obtain the savings and effective costs to each party and the dealers pay-receive spread from swapping.

Answer 1

AA

Borrow at Fixed Rate	-12.75%
Pay floting rate on swap	-8%
Receive fixed rate on swap	13.20%
Effective Rate	-7.55%

AA can borrow at an effective floating rate of 7.55% vs rate of 7.75% if he would have borrowed directly

Saving = 0.20%

BB

Borrow at floting Rate	-8.10%
Pay floting rate on swap	-13.30%
Receive fixed rate on swap	8.00%
Effective Rate	-13.40%

BB can borrow at an effective Fixed rate of 13.40% vs rate of 13.55% if he would have borrowed directly

Saving = 0.15%

Same is shown in swap diagram below