2. Caterpillar (CAT), a US multinational, wants to borrow 150 million Canadian dollars at a fixed rate of interest for five years. Algoma Steel, a Canadian integrated steel manufacturer, wants to borrow 100 million US dollars at a floating rate of interest for five years. (The current exchange rate is 1.50 CAD/USD.) They have been quoted the following annual rates for five-year loans. Caterpillar Algoma Steel b) c) CAD 7.8% 6.0% USD LIBOR + 1.2% LIBOR +0.6% a) Design a swap that will net a bank, acting as an intermediary, 40 basis points per annum. Make the swap equally attractive to the companies and ensure that the bank assumes all foreign exchange risk. What are the borrowing rates for both companies after they enter into the swap? Illustrate the swap with a diagram. Provide a numerical example how the bank could hedge exchange rate risk in a). Describe how the swap contract will be designed so both companies share the total gain equally if there is no bank acting as an intermediary and one of the companies also has no exposure to exchange rate risk.
2. Caterpillar (CAT), a US multinational, wants to borrow 150 million Canadian dollars at a fixed rate of interest for five years. Algoma Steel, a Canadian integrated steel manufacturer, wants to borrow 100 million US dollars at a floating rate of interest for five years. (The current exchange rate is 1.50 CAD/USD.) They have been quoted the following annual rates for five-year loans. Caterpillar Algoma Steel b) c) CAD 7.8% 6.0% USD LIBOR + 1.2% LIBOR +0.6% a) Design a swap that will net a bank, acting as an intermediary, 40 basis points per annum. Make the swap equally attractive to the companies and ensure that the bank assumes all foreign exchange risk. What are the borrowing rates for both companies after they enter into the swap? Illustrate the swap with a diagram. Provide a numerical example how the bank could hedge exchange rate risk in a). Describe how the swap contract will be designed so both companies share the total gain equally if there is no bank acting as an intermediary and one of the companies also has no exposure to exchange rate risk.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:2. Caterpillar (CAT), a US multinational, wants to borrow 150 million Canadian dollars at a fixed rate of interest
for five years. Algoma Steel, a Canadian integrated steel manufacturer, wants to borrow 100 million US
dollars at a floating rate of interest for five years. (The current exchange rate is 1.50 CAD/USD.) They have
been quoted the following annual rates for five-year loans.
CAD
USD
Caterpillar
Algoma Steel
7.8%
LIBOR + 1.2%
6.0%
LIBOR + 0.6%
a) Design a swap that will net a bank, acting as an intermediary, 40 basis points per annum. Make the
swap equally attractive to the companies and ensure that the bank assumes all foreign exchange
risk. What are the borrowing rates for both companies after they enter into the swap? Illustrate the
swap with a diagram.
b) Provide a numerical example how the bank could hedge exchange rate risk in a).
c) Describe how the swap contract will be designed so both companies share the total gain equally if
there is no bank acting as an intermediary and one of the companies also has no exposure to
exchange rate risk.
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