Question

Consider this scenario: An American company would like to barrow fixed-rate yen. They can barrow fixed-rate yen at 5.4% or floating-rate dollars at LIBOR + 1.24%. There is also an Asian company who would like to borrow floating-rate dollars. They can borrow fixed-rate yen at 5.8% or floating-rate dollars at LIBOR + 1.7%. What is the total cost savings which can be realized through an interest rate/currency swap between the two?

Answer 1

In a swap, both companies will borrow at the opposite rate of what they desire. So, American company will borrow @LIBOR + 1.24% and Asian company will borrow @5.8%. They will then, enter a swap agreement, where American company will take the fixed rate of the Asian company and Asian company will take the floating rate of the American company.

Now, American company could borrow locally @5.4% but in the swap, they are getting a rate @5.8%. So, it is at a loss of 0.40%. This loss will be compensated from the mutual swap cost savings or gain.

The Asian company could borrow locally @ LIBOR + 1.7% whereas in the swap, it is getting a rate @ LIBOR + 1.24%. So, their is a gain of 0.46%.

Net cost savings = 0.46% - 0.40% = 0.06%

This gain will be shared equally among the two.