Deutsche Bank, a German investment bank wants to finance an AUD 20 million expansion in Australia. The firm could raise EUR 16 million in the Euro capital markets at 5% while its cost of borrowing in Australia would be 8%. A Swap bank has arranged a currency swap with Australian firm Suncorp that is looking to raise EUR 16 million. Suncorp faces a borrowing rate of 9% on AUD20 million in Australia and 6.5% in the Euro bond market. The Swap bank quotes AUD swaps at 7.00 – 7.15 and EUR swaps at 5.00 – 5.10. The spot rate is 1.25 AUD = 1 EUR.

a. In which currency does Deutsche Bank have comparative advantage?

b. Explain why Deutsche Bank might face such an unfavourable borrowing rate in Australia.

c. What will the benefit be of the swap (in AUD) for Deutsche Bank? Support your answer with calculations.