John was learning about currency swap agreements. John was confused why would company A agree to such a swap agreement. If we take a look at the interest rate offered to both companies from the market:

Based on the market offer, company A has the comparative advantage of borrowing U.S. dollar, and company B has the comparative advantage of borrowing British pound (it is intuitive since company A is headquartered in U.S. and company B is headquartered in U.K.). However, company A wants British pound for its U.K. expansion, while company B wants U.S. dollar for its U.S. expansion.

The swap agreement: company A borrows U.S. dollar at 8% from the market, and company B borrows British pound at 12% from the market. Then they sit down and do the swap. After the swap, A pays net 11% on the British pound, and B pays net 9.4% on U.S. dollar.

The problem is, it looks like company B is completely ripping company A off!

John's question was,why doesn't company A just borrow U.S. dollar and exchange it to British pound to fund its business?This way, company A only pays 8% interest on U.S. dollar. Why on earth would company A agree to such a swap and eventually pay 11% interest on the British pound, even though 11% interest rate on British pound is 0.6% lower than the U.K. market offers? Why on earth would company A ever want to pay interest based on U.K. market rate which is much higher than the rate in U.S. market?

John\twas\tlearning\tabout\tcurrency\tswap\tagreements.\tJohn\twas\tconfused\twhy\twould\tcompany\tA\tagree\tto such\ta\tswap\tagreement.\tIf\twe\ttake\ta\tlook\tat\tthe\tinterest\trate\toffered\tto\tboth\tcompanies\tfrom\tthe market: Borrow\tU.S.\tDollar Borrow\tBritish\tPound Company\tA 8% 11.6% Company\tB 10% 12% Based\ton\tthe\tmarket\toffer,\tcompany\tA\thas\tthe\tcomparative\tadvantage\tof\tborrowing\tU.S.\tdollar,\tand company\tB\thas\tthe\tcomparative\tadvantage\tof\tborrowing\tBritish\tpound\t(it\tis\tintuitive\tsince\tcompany\tA\tis headquartered\tin\tU.S.\tand\tcompany\tB\tis\theadquartered\tin\tU.K.).\tHowever,\tcompany\tA\twants\tBritish pound\tfor\tits\tU.K.\texpansion,\twhile\tcompany\tB\twants\tU.S.\tdollar\tfor\tits\tU.S.\texpansion. The\tswap\tagreement:\tcompany\tA\tborrows\tU.S.\tdollar\tat\t8%\tfrom\tthe\tmarket,\tand\tcompany\tB\tborrows British\tpound\tat\t12%\tfrom\tthe\tmarket.\tThen\tthey\tsit\tdown\tand\tdo\tthe\tswap.\tAfter\tthe\tswap,\tA\tpays\tnet 11%\ton\tthe\tBritish\tpound,\tand\tB\tpays\tnet\t9.4%\ton\tU.S.\tdollar. The\tproblem\tis,\tit\tlooks\tlike\tcompany\tB\tis\tcompletely\tripping\tcompany\tA\toff! John's\tquestion\twas,\twhy\tdoesn't\tcompany\tA\tjust\tborrow\tU.S.\tdollar\tand\texchange\tit\tto\tBritish\tpound to\tfund\tits\tbusiness?\tThis\tway,\tcompany\tA\tonly\tpays\t8%\tinterest\ton\tU.S.\tdollar.\tWhy\ton\tearth\twould company\tA\tagree\tto\tsuch\ta\tswap\tand\teventually\tpay\t11%\tinterest\ton\tthe\tBritish\tpound,\teven\tthough 11%\tinterest\trate\ton\tBritish\tpound\tis\t0.6%\tlower\tthan\tthe\tU.K.\tmarket\toffers?\tWhy\ton\tearth\twould company\tA\tever\twant\tto\tpay\tinterest\tbased\ton\tU.K.\tmarket\trate\twhich\tis\tmuch\thigher\tthan\tthe\trate\tin U.S.\tmarket