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Lost, Inc., a U.S. company, would like to borrow euros, whereas Potter, Inc., a U.K. company,...

Lost, Inc., a U.S. company, would like to borrow euros, whereas Potter, Inc., a U.K. company, would like to borrow dollars. Lost can borrow fixed-rate dollars at 2% or euros at 7%. Potter can borrow dollars at 3% or euros at 8%. Can these firms use a currency swap to lower their cost of debt? How do you know?

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Answer #1
Interest Rates Applicable on Loans
Lost Inc., Potter Inc.,
Dollars 2% 3%
Euro 7% 8%
Particulars Lost Inc., Potter Inc., Total Interest
(US Company) (UK Company) (as a percent on
Required Currency Euros Dollars Loan Amount)
Interest Rate Applicable 7% 3% 10%
If Currency Swap is Used
Loan Currency Dollars Euros
Applicable Interest Rate 2% 8% 10%

No, the firms cannot use a currency swap to lower their cost of debt, as the effective cost of debt is 10% of Amount borrowed irrespective of Swaption.

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