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 $2.00*(1.08)/€1.00*(1.06) = $2.0377/€1.Is there a mutually beneficial swap?
A)No, QSD = 0
B)Yes, QSD = 2% = (7% - 6%) - (8% - 9%) = 1% - (-1%)
C)Yes, QSD = [€7% - €6%]*$2.00/€1.00 - ($8% - $9%) = $2% + $1% = $3%
D)Yes, QSD = [€7% - €6%]- ($8% - $9%)*€1.00/$2.00= €1½%

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 $2.00*(1.08)/€1.00*(1.06) = $2.0377/€1.Is there a mutually beneficial swap?
A)No, QSD = 0 
B)Yes, QSD = 2% = (7% - 6%) - (8% - 9%) = 1% - (-1%) 
C)Yes, QSD = [€7% - €6%]*$2.00/€1.00 - ($8% - $9%) = $2% + $1% = $3% 
D)Yes, QSD = [€7% - €6%]- ($8% - $9%)*€1.00/$2.00= €1½%

Quizplus · Accepted Answer

To determine if there is a mutually beneficial swap, we need to calculate the Quoted Swap Differential (QSD) using the formula:
QSD = (foreign currency interest rate - domestic currency interest rate) - (forward premium - forward discount)

For Firm A:
QSD = (€7% - €6%) - ($2.0377/€1.00 - $2.00/€1.00)
QSD = 1% - (-2.77%)
QSD = 3.77% (negative QSD indicates no mutually beneficial swap)

For Firm B:
QSD = ($9% - $8%) - ($2.0377/€1.00 - $2.00/€1.00)
QSD = 1% - (-2.77%)
QSD = 3.77% (negative QSD indicates no mutually beneficial swap)

Therefore, the only answer choice that is correct is B, as both firms cannot benefit from a swap.

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