The profit generated by the subsidiary in the U.K. is considered as a good source of money to be used to pay for the import of manufacturing equipment from Japan for the electronic component plant in the U.S.A. The CEO has already entered into negotiations with the Japan supplier of the equipment.  The supplier is willing to provide HighTech  3 years to pay for the equipment that will be shipped to HighTech, but the payments must be conducted with quarterly instalments of 5,250,000 Yen by the U.K. subsidiary. This is why the CEO wants you to construct a currency swap arrangement where the profits of the U.K. subsidiary can be used to pay for the equipment. You have to apply the swap bank quotes to conduct this three year swap and also depict the swap graphically for the CEO to see how the swap will work. Relevant information, that you will require are provided below:

Exchange rates:	Spot
	Bid	Ask
$/JPY	0.0094	0.0095

 

Current borrowing interest rates on loans:				Fixed		Libor
USA				0.640%		0.130%
Japan				0.525%		0.015%
South Korea				1.164%		0.654%
Canada				0.666%		0.156%
UK				0.577%		0.067%
Australia				0.612%		0.102%
South Africa				5.045%		4.535%
BANK CURRENCY SWAP INTEREST RATE QUOTES AGAINST U.S. LIBOR RATE
	$		Yen
Years	Bid%	Ask%	Bid%		Ask%
1	0.630	0.650	0.515		0.535
2	0.640	0.660	0.525		0.545
3	0.650	0.670	0.535		0.555
4	0.660	0.680	0.545		0.565
5	0.670	0.690	0.555		0.575
6	0.680	0.700	0.565		0.585
7	0.690	0.710	0.575		0.595
8	0.700	0.720	0.585		0.605
9	0.710	0.730	0.595		0.615
10	0.720	0.740	0.605		0.625

 

Other summarised information:
United Kingdom  subsidiary profits generated quarterly:		£500,000
Import cost of equipment/machinery for the manufacturing of electronic components in the U.S.A:		¥63,000,000
	Period of time that the components can be paid (in years)	3
	Number of payments per year	4
	Amount of each payment:	¥5,250,000

a. Complete the diagram below to show the swap transaction graphically by inserting the correct interest rate or currency values below:

UK subsidiary

GBP notional principal =

 

Notional GBP swap

principal

Japanese

exporter

 Yen notional principal =

 

 

notional principal = ¥3,925,233,644.86

 

Notional Yen swap

principal

b. Explain to the CEO what forfaiting is, why it is possible that forfaiting of the transaction can occur and  the implication that it will have on the swap transaction. 

What is forfaiting? (Give an explanation).
Why can forfaiting occur?
Implication on the swap transaction (State whether it impacts the swap or not and the reason for it).