US Co., Inc. is planning to expand by building a €106.00 million ($106 million) facility in Spain. It can borrow dollars or euros at 6.25% the market.Irish Co., Ltd. is planning a $106 million capital investment in the US. It can borrow euros at 5.50% or dollars at 5.75% in the market.
a. Explain what a swap broker would recommend each company do so the swap broker can structure a parallel loan arrangement with each company giving each a better net loan deal than it can get in the market, and the swap broker can realize a profit. Indicate (1) which loan each company should obtain in the market, what the terms of the loan (2) from each company to the swap broker and (3) from the swap broker to each company should be, (4) what the total net payment is for each company (as a percent of the principal), and (5) the profit the swap broker realizes on each payment (in dollars or euros).
b. Specify the equation for a swap that will replace the parallel loan arrangement with each company in part a. (Standard notation for an interest rate swap is: notional principal*(interest rate in dollars – rate in euros*exchange ratet (in dollars per euro), or notional principal*( interest rate in euros – rate in dollars*exchange ratet (in euros per dollar).