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Company Zulu is a U
Subject:BusinessPrice:9.82 Bought3
Company Zulu is a U.S. MNC and wants to borrow E60 million for 3 years. Company Yankee is a French MNC and wants to borrow $90 million for 3 years. Company Zulu wants finance euro denominated asset in Italy and therefore wants to borrow euro. Company Yankee wants to finance a dollar denominated asset and therefore wants to borrow dollars. The current exchange rate is $1.50 = (1.00. If Company Zulu and Company Yankee knew and trusted each other, they could theoretically cut out the swap bank.
Firm Zulu Firm Yankee
$8.5% $9.5%
E6.8% E5.8%
Required:
(a) Calculate the quality spread differential (QSD). [3 marks]
(b) Develop a swap in which both companies have an equal cost savings in their borrowing costs. Calculate all in costs for each company. [7 marks]
(c) Draw the cash flow chart of both companies. [10 marks]
(d) Briefly describe the benefit of the swap. [6 marks]
(e) How much interest rate Company Zulu gains from swap per year? Briefly explain your result. [4 marks]
[Total: 30 marks]
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REQUIRED:
Problem a: Calculate the quality spread differential (QSD).
QSD = 2%
Problem b: Develop swap which both companies have an equal cost savings in there borrowing costs. Calculate all in costs each company.
TOTAL Costs = 500,000
Problem c: Draw the cash flow chart of both companies.
(Please see image attach below explanation).
Problem d: Briefly describe the benefit of the swap.
Benefits of swap can access to new financial markets. Because Swaps are utilized to gain access to new financial markets for funds by examining the other party's comparative advantage in that market.
Problem e: How much interest rate Company Zulu gains form swap per year? Briefly explain your result.
TOTAL Interest Rate - Zulu = 2.7%
Step-by-step explanation
REQUIRED:
Problem a: Calculate the quality spread differential (QSD).
To Calculate: The QSD is calculated by subtracting the contracted market rate by the rate available to the counter-party on similar rate instruments. When the QSD is positive, the swap is considered to benefit both parties involved.
Thus,
| $ | € | ||
| Zulu | 8.5% | 6.8% | |
| Yankee | 9.5% | 5.8% | |
| QSD | 1% | 1% | 2% |
Problem b: Develop swap which both companies have an equal cost savings in there borrowing costs. Calculate all in costs each company.
Total borrow divided by Number of Periods multiplied by QSD.
Thus,
| Zulu (€60 million / 3 years) x 1% | 200,000 |
| Yankee ($90 million / 3 years) x 1% | 300,000 |
| TOTAL Costs | 500,000 |
Problem c: Draw the cash flow chart of both companies.
Please see attached file
Problem d: Briefly describe the benefit of the swap.
Benefits of swap can access to new financial markets. Because Swaps are utilized to gain access to new financial markets for funds by examining the other party's comparative advantage in that market. As a result, parties' comparative advantages are fully leveraged through swap. As a result, cash can be secured at the best possible rates from the best possible source. Also, the borrowing will be at lower cost and swap allows for lower-cost borrowing. The borrower trades his comparative advantage for the comparative advantage of the other borrower. As a result, both parties will be able to obtain funds at a lower cost.
Problem e: How much interest rate Company Zulu gains form swap per year? Briefly explain your result.
Total Costs divided by Total borrow multiplied by 100. Then add the total Swap rate of Zulu.
Thus,
| Total Costs | 200,000 |
| Divided by: Total borrow (€60 million / 3 years) | 20,000,000 |
| Total | 0.01 |
| Multiplied by: | 100 |
| Total | 1% |
| Add: Swap Rate ($8.5% - €6.8%) | 1.7% |
| TOTAL Interest Rate - Zulu | 2.7% |
