U is a U.S.-based MNC with AAA credit; I is an Italian firm with AAA credit. Firm U wants to borrow 1,000,000 for two years and I wants to borrow $1,100,000 for two years. The spot exchange rate is 1.10$/, a swap bank makes the following quotes for 2-year swaps and AAArated firms against USD LIBOR: USD EUR Bid Ask Bid Ask 2% 2.1% 1.5% 1.6% The firms external borrowing opportunities are: Euro Borrowing USD Borrowing I 1.5% $2.5% U 2.0% $2% You represent the swap bank.

a. Calculate the QSD and show the firms that there exists an advantage to swap.

b. Lay out the exact proposal for the swaps for the two firms. That is advise them on their borrowing decision and their swap contracts.

c. Calculate the absolute benefit denominated in USD to firms U & I and the swap bank.

d. A fresh MBA claims that the US firm should be indifferent between borrowing at the Euro rate of 2% or the USD rate of 2%. Comment.