Question
Caterpillar (CAT), a US multinational, wants to borrow 150 million Canadian dollars at a fixed rate of interest for five years. Algoma Steel, a Canadian
Caterpillar (CAT), a US multinational, wants to borrow 150 million Canadian dollars at a fixed rate of interest for five years. Algoma Steel, a Canadian integrated steel manufacturer, wants to borrow 100 million US dollars at a floating rate of interest for five years. (The current exchange rate is 1.50 CAD/USD.) They have been quoted the following annual rates for five-year loans.
CAD | USD | |
CAT | 7.8% | LIBOR + 1.2% |
Algoma | 6% | LIBOR + 0.6% |
a) Design a swap that will net a bank, acting as an intermediary, 40 basis points per annum. Make the swap equally attractive to the companies and ensure that the bank assumes all foreign exchange risk. What are the borrowing rates for both companies after they enter into the swap? Illustrate the swap with a diagram.
b) Provide a numerical example how the bank could hedge exchange rate risk in a).
c) Describe how the swap contract will be designed so both companies share the total gain equally if there is no bank acting as an intermediary and one of the companies also has no exposure to exchange rate risk.
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