Company A,  wishes to borrow U.S dollars at a fixed rate of interest. Company B, wishes to borrow Japanese yen at a fixed rate of interest. The amounts required by the two companies are roughly the same at the current exchange rate. The companies have been quoted the following interest rates: 
Company A 
Yen -4.8%
Dollars-9.6%

Company B
Yen -9.6%
Dollars- 10.0%


Design  a swap that will net a bank, acting as intermediary, 20 basis points per annum. Make a swap appear equally attractive to the two companies and ensure that all foreign exchange risks are not assumed by the company A and bank.

Companies X and Y have been offered the following rates per annum on a $20 million five-year loan: Fixed Rate Floating Rate Company X 6% LIBOR + 0.25% Company Y 8.4% LIBOR + 1.25% Company X requires a floating-rate loan; company Y requires a fixed rate investment. Design a swap that will net a bank, acting as intermediary, 50bps per annum and appear to be equally attractive to X and Y.

Question 1 (50 marks)

Leopard Automobile is a car manufacturing company and Road Creation is a 4A advertising firm. Leopard Automobile is looking for a floating rate loan, while Road Creation targets a fixed rate loan. The two companies have been offered the following borrowing rates on a $100 million 2-year loan:

Required:

a What is the interest rate difference in borrowing a fixed rate loan between the two companies? What is the difference in borrowing a floating rate loan? Which company has a comparative advantage in the fixed rate loan and which company has a comparative advantage in the floating rate loan? Please explain. (10 marks)

b Suppose you are the Manager of the Bank and the two companies are your long-time customers. Design a swap structure that will allow your bank to be an intermediary with 0.40% per annum profit, and that both Leopard Automobile and Road Creation can benefit equally. (16 marks)

c If Road Creation agrees to engage the swap contract with the Bank according to the structure you proposed, evaluate the firm’s net borrowing cost. Compared with direct borrowing in the market, how many percentage points can Road Creation save from the swap contract? (12 marks)

Given the following: US Dollars Swiss Francs Firm LMN 10 pct. 7 pct. Firm XYZ 8 pct. 6 pct. The above borrowing rates represent the borrowing rates the firms can obtain for a five year fixed rate debt issue in U.S. dollars or Swiss francs. Suppose XYZ wishes to borrow Swiss francs and LMN wishes to borrow U.S. dollars. LMN demands a 10 pct cost of borrowing . First step is for XYZ to borrow $1000 at its 8 percent rate. Using a swap demonstrate, explain how the borrowing costs of each company could be reduced. Assume the spot exchange rate of 2 Swiss francs per dollar. EXPLAIN IN DETAIL PLEASE