lecturederivativeII.pptVIP

* * * * * * * * * IBM’s obligations under the currency swap * IBM’s Cash flows under the currency swap * * * QANTAS pays AUD13.0% to AUS lenders pays USD 6.3% to FI receives from FI AUD13.0% net interest payments = -13.0 - 6.31 + 13.0 = 6.3% p.a QANTAS transforms AUD loan of 13% p.a into USD loan at 6.3%; QANTAS is better off by 0.7%p.a than it would be if it went to US market directly GM pays USD 5.0% to US lenders pays AUD 11.9% to FI receives from FI USD5.0% net interest payments = -5.0 - 11.9 + 5.0 = 11.9% p.a GM transforms USD loan of 5% p.a into ASD loan at 11.9%; GM is better off by 0.7%p.a than it would be if it went to AUS market directly FI Fi gains 1.3%p.a on USD cashflows and losses 1.1% on AUD cashflows net gain to FI = 0.2% p.a Total gains = 0.7% + 0.7% + 0.2% = 1.6% p.a * The Cash Flows Dollars Pounds Years $ ------millions------ 0 –18.00 +10.00 1 +1.08 –0.5 2 +1.08 –0.5 3 +1.08 –0.5 4 +1.08 –0.5 5 +19.08 -10.5 ￡ Comparative Advantage Arguments for Currency Swaps General Motors wants to borrow AUD Qantas wants to borrow USD * USD AUD General Motors 5.0% 12.6% Qantas 7.0% 13.0% Currency Swap Differential in US market = (7% - 5%) = 2%p.a Differential in AUS market = (13.0% - 12.6%) = 0.4% p.a Total gain to both parties in swap = 1.6% p.a GM has a comparative advantage in raising USD loans QANTAS has comparative advantage in raising AUD loans GM F.I. Qantas USD 5% AUD 11.9% AUD 13.0% AUD 13% USD 5.0% USD 6.3% Qantas: net interest payments = -13.0 - 6.31 + 13.0 = -6.3% p.a (USD) compare to 7% GM: net interest payments = -5.0 - 11.9 + 5.0 = -11.9% p.a (AUD) Compare to 12.6% Fi: gains 1.3%p.a on USD cashflows and losses 1.1% on AUD cashflows net gain to FI = 0.2% p.a USD AUD General Motors 5.0% 12.6% Qantas 7.0% 13.0% Cash flows of currency swap Currency swaps usually involve both parties exchanging the interest and principal payments. A wants to exchange $10m with B for euros, and the spot is $1.25/€. Then