Currency Swap Assignment: International Finance
Structure EUR:USD $100m Notional Currency Swap
Two corporations each having subsidiaries in the others’ country would like to collaboratively structure a currency swap to reduce the cost of funding their subsidiaries:
1. US Corporation with a new subsidiary in Berlin, GDR
a. Prefers borrowing EUR equivalent of USD 100m for one year in quarterly coupon payments
b. Can borrow offshore in German Foreign Bond Market @ credit spread of 500bp
c. Can borrow onshore in US Domestic Bond Market @ credit spread of 300bp
2. GDR Corporation with a new subsidiary in San Francisco CA
a. Prefers borrowing USD 100m for one year in quarterly coupon payments
b. Can borrow offshore in US Foreign Bond Market @ credit spread of 400bp
c. Can borrow onshore in German Domestic Bond Market @ credit spread of 200bp
You job is to structure a fair swap for both corporations without any intermediary between them. In order for both counterparties to transact, you must assure them that:
1. The initial MTM of the swap is approximately zero, i.e. NPVs of each side’s cashflow is close to zero when using their home currency and its discount rates.
2. Both parties will save significantly and equally compared to their alternative funding costs in the foreign bond
3. Each swap party will borrow in its preferred currency without taking excess fx risk.
Tips
1. Gather EUR:USD spot rate and 3m/6m/9m/12m forward points from this web broker:
https://www.investing.com/currencies/single-currency-crosses
to determine market forward quotes.
2. Gather Euribor and USD Libor rates 3m/6m/9m/12m from this website. Note that 9m quotes are not generally available so interpolate (average) between 6m and 12m to estimate 9m:
https://www.global-rates.com/interest-rates/interest-rates.aspx
Use these rates to calculate each currency’s discount factor and determine theoretical forward fx rates.
3. To determine which pairing of swap payments create a zero MTM swap structure, use Goal Seek or Solver in your spreadsheet software.
4. Remember that cashflows of each counterparty should be done using their home currency’s discount rates and theoretical forwards.
5. Remember that the PV of combined cashflows from the swap and domestic bond issue must be significantly lower than each counterparty’s alternative PV cashflows in the foreign bond market. Ideally both parties should be saving approximately an equal amount.