Question

Grant, Inc., is a well-known U.S. firm that needs to borrow 10 million British pounds to support a new business in the United Kingdom. However, it cannot obtain financing from British banks because it is not yet established within the United Kingdom. It decides to issue dollar-denominated debt (at par value) in the U.S., for which it will pay an annual coupon rate of 10%. It then will convert the dollar proceeds from the debt issue into British pounds at the prevailing spot rate (the prevailing spot rate is one pound = $1.70). Over each of the next three years, it plans to use the revenue in pounds from the new business in the United Kingdom to make its annual debt payment. Grant, Inc., engages in a currency swap in which it will convert pounds to dollars at an exchange rate of $1.70 per pound at the end of each of the next three years. How many dollars must be borrowed initially to support the new business in the United Kingdom? How many pounds should Grant, Inc., specify in the swap agreement that it will swap over each of the next three years in exchange for dollars so that it can make its annual coupon payments to the U.S. creditors?

Answer 1

Amount required in UK in GBP = GBP 10 million

Current spot rate GBP = $1.70

1) Amount required to be borrowed in the US = GBP 10 million * 1.70 = $17 million

Interest rate on the US borrowings = 10%

Interest amount to be paid every year on US borrowings= 10% * 17 = $1.7 million

Currency swap to exchange the amount from GBP to USD is $1.70

Amount of GBP pound required to be paid in swap agreement = Interest amount in USD / Currency swap rate

= 1.7 / 1.70

2) Amount of GBP pound required to be paid in swap agreement for the interest payment in USD = GBP 1 million