Consider the currency Swap between firm A and firm B. Firm A is able to borrow i
ID: 1155653 • Letter: C
Question
Consider the currency Swap between firm A and firm B. Firm A is able to borrow in the European market at 8.75% per annum (fixed rate) and at the floating rate of LIBOR - 0.25%. Firm B is able to borrow in the fixed market rate equal to 9.50% and at the floating rate of LIBOR + 1.10%. Which of the following is true?
Select one:
a. The swap between A and B is mutually advantageous and reflects a case of gains from absolute advantage.
b. The swap between A and B is mutually advantageous and reflects a case of gains from comparative advantage.
c. The swap between A and B is not mutually advantageous and should not be carried out.
d. Forward transactions would have been better than swap transactions for firm A.
e. None of the above.
Explanation / Answer
Ans. Here, Firm A's total interest rate will be = Fixed plus floating libor = 8.75+0.25 = 9.00 %. While the Firm B's total interest rate will be = 9.5 + 1.10 = 10.60 %. The correct option will be C i.e. The swap between A and B is not mutually advantageous and should not be carried out. This is because in the above scenario only firm A will benefit while B will not benefit after calculating the diiferences in their rates.