Currency swaps and the cost of debt. Michelin S.A., the French multinational tire manufacturer, needs to borrow $300 million to expand its U.S. plant in Georgia.

It can issue a US$-denominated five-year note at 6 percent while a similar note denominated in euros would cost 4 percent. E.I. Dupont de Nemours Inc., the U.S. chemical firm, wants to hedge its long-term euro exposure because of its Spanish operations and is considering issuing a €250 million five-year note at 4. 5 percent, whereas its cost of debt for a similar U.S. dollar note issue is 5. 5 percent.

a. Explain how a currency swap could help both firms to lower their cost of debt. Given that both firms are AAA-rated, how do you explain such cost of capital differences?

b. Given that at time of issue the exchange rate is US$1.20 = €1, explain preand post-swap cash flows.

c. What are the annual cash-flow payments/receipts in years 1 through 5?

d. Show actual cash-flow payments by either firm at maturity of the loan, assuming that the exchange rate at the end of year 5 is exactly what was predicted by interest rate parity at the inception of the swap.