Consider the dollar- and euro-based borrowing opportunities of companies A and B. $\begin{array}{ccc}
& € \text { borrowing } & \$ \text { borrowing } \
\mathrm{A} & € 7 \% & \$ 8 \% \
\mathrm{~B} & € 6 \% & \$ 9 \%
\end{array}$ 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. $\begin{array}{ccc} 
& € \text { borrowing } & \$ \text { borrowing } \
\mathrm{A} & € 7 \% & \$ 8 \% \
\mathrm{~B} & € 6 \% & \$ 9 \%
\end{array}$ 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

The Quality Spread Differential (QSD) is calculated as the difference in interest rates for borrowing in euros minus the difference in interest rates for borrowing in dollars. Here, it is (7% - 6%) - (8% - 9%) = 1% - (-1%) = 2%. This indicates a mutually beneficial swap opportunity exists because both companies can potentially save on their borrowing costs by swapping their debt obligations.

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