Swap

Suppose a U.S. MNC wants to finance a 10,000,000 expansion of a British plant. They could borrow dollars in the U.S. where they are well known and exchange for dollars for pounds. This will give them exchange rate risk: financing a sterling project with dollars.

They could borrow pounds in the international bond market, but pay a premium since they are not as well-known abroad.

If they can find a British MNC with a mirror-image financing need they may both benefit from a swap.

If the spot exchange rate is S₀($/) = $1.60/, the U.S. firm needs to find a British firm wanting to finance dollar borrowing in the amount of $16,000,000.

Consider two firms A and B: firm A is a U.S.based multinational and firm B is a U.K.based multinational.

Both firms wish to finance a project in each others country of the same size. Their borrowing opportunities are given in the table below.

	$
Company A	8.0%	11.6%
Company B	10%	12%

Swap bank offers the opportunity for swap to companies A and B as follows:

Accepts 11% from Company A and offers $8% to Company A.

Accepts $9.4% from Company B and offers 12% to company B.

Find the net positions of each companies (that is, what rate and in which currencies) they end up paying? Also find the swap banks profit.