Consider the dollar- and euro-based borrowing opportunities of companies A and B .
A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit.Firm A wants to borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year.The spot exchange rate is $2.00 = €1.00 and the one-year forward rate is given by IRP as:
.Suppose they agree to the swap shown at right.Is this mutually beneficial swap equally fair to both parties?
A)Yes, QSD = [€7% - €6% * $2.00/€1.00 - ($8% - $9%) = $2% + $1% = $3%
B)No, company A borrows at 6% in euro but company B borrows at 8% in dollars
C)Yes, A will be better off by €1% on €1m; B by 1% on $2m and $2.00 = €1.00
D)No, company A saves 1% in euro but company B saves only 1% in dollars when the spot exchange rate is $2.00 = €1.00-A is twice as better off as B

Question

Consider the dollar- and euro-based borrowing opportunities of companies A and B .  
A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit.Firm A wants to borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year.The spot exchange rate is $2.00 = €1.00 and the one-year forward rate is given by IRP as: 
 .Suppose they agree to the swap shown at right.Is this mutually beneficial swap equally fair to both parties? 
A)Yes, QSD = [€7% - €6% * $2.00/€1.00 - ($8% - $9%) = $2% + $1% = $3% 
B)No, company A borrows at 6% in euro but company B borrows at 8% in dollars 
C)Yes, A will be better off by €1% on €1m; B by 1% on $2m and $2.00 = €1.00 
D)No, company A saves 1% in euro but company B saves only 1% in dollars when the spot exchange rate is $2.00 = €1.00-A is twice as better off as B

Quizplus · Accepted Answer

The swap is mutually beneficial and equally fair to both parties because the Quick Spread Differential (QSD) is positive, which means that both companies are saving money compared to borrowing in their own currency. Company A saves 1% on €1,000,000 and company B saves 1% on $2,000,000, and the exchange rate of $2.00 = €1.00 ensures that the swap is fair.

Consider the Dollar- and Euro-Based Borrowing Opportunities of Companies a and B