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Companies A and B have excess cash on their balance sheets, which they would like to invest. Company A is being offered an investment rate
Companies A and B have excess cash on their balance sheets, which they would like to invest. Company A is being offered an investment rate of 2.2% per annum in the United States and 2.9% in Australia while Company B is being offered 2.0% in the United States and 2.1% in Australia. A is desirous of receiving a USD return while B is desirous of a AUD return. A financial institution will arrange the swap for 20 basis points. Design a swap that will be equally attractive to A and B. What investment rates will A and B effectively end up receiving and in what currency? Who bears the foreign exchange risk? What is the financial institution's spread? Assuming that the forward exchange rates are an indicator of future exchange rates, will the spread be expected to increase or decrease over time? Why? What happens if A defaults - who bears the risk and what is the risk? What happens if B defaults - who bears the risk and what is the risk
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