Swap Comparative Advantage for Currency Swaps (10%) XXX wants to borrow USD YYY & Co wants to borrow EURO EURO USD XXX YYY 3.25% 4.75% 6,75% 5,50% Design a swap that will net a bank, acting as intermediary 0,1% (10 basis points) per annum. Make the swap equally attractive to the two companies and ensure that all foreign exchange rate is assumed by the bank.

Please find the solution as below:

Step 1 - XXX wants to borrow USD. Y& Co wants to borrow EUR.

From the given table, it is clear that XXX has comparative advantage for EUR because advantage of borrowing in EUR is 1.5% (4.75-3.25)%.

Step 2 - If XXX borrows in EUR and Y&Co borrows in USDd and then enter into a swap then it is beneficial for both the companies.

Total Cost without swap = 4.75%+6.75% = 11.5%

Total cost with swap = 3.25% + 5.5% = 8.75%

Total benefit of such a swap = 11.5 - 8.75 = 2.75%

Step 3 - 0.1% paid to intermediary for entering into swap. Therefore, (2.75-0.1)% will be shared between XXX and Y&co equally i.e. 1.325% each.

Effective cost to XXX = 6.75-1.325 = 5.425%

Effective cost to Y & Co = 4.75-1.325 = 3.425%