Please show work Johnson Corp. has not tapped the Deutsche mark public debt mark
ID: 2724879 • Letter: P
Question
Please show work
Johnson Corp. has not tapped the Deutsche mark public debt market because of concern about a likely appreciation of that currency and only wishes to be a floating rate dollar borrower, which it can be at LIBOR + 1.1%. Apex Corp. strongly prefers fixed rate DM debt, but it must pay 1.6% more than the 6.25% coupon that Johnson’s DM notes would carry. Apex, however, can obtain Eurodollars at LIBOR + 0.5%.
1. (a) What is the maximum possible cost savings to Johnson from engaging in a currency swap with Apex?
2. (b) Suppose a bank charges .7% to arrange the swap and Johnson and Apex split the resulting cost savings. Calculate borrowing cost for each company.
Explanation / Answer
Answer:1(a)
Johnson's maximum possible cost savings is 2.2%: Johnson borrows Mark at 6.25%, then enter currency swap with Apx to receive 6.25%+1.6% and pay Libor+0.5%. The total cost of these transactions is 6.25% +(Libor+0.5%)-(6.25%+1.6%) = Libor-1.1%. So instead of borrowing at Libor +1.1%, doing these above transaction Johnson only has to pay Libor-1.1%, therefore the cost savings is Libor+1.1%-(Libor-1.1%)=2.2%.
Answer:2 (b) interest rate and currency swaps
2.2%-0.7%=1.5%. Johnson will receive savings of 1.5%/2=0.75%
Its new cost is Libor+1.1%-0.75%=Libor+0.35%.
Apex new cost=6.25%+1.6%-0.75%=7.1%
Dollar-denominated Debt Mark-denominated Debt Johnson LIBOR + 1.1% 6.25% Apex LIBOR + 0.5%. 1.6%+6.25%