Interest rate and currency swaps

Question 1

A U.S. company needs to raise €50,000,000. It plans to raise this money by issuing dollar
denominated bonds and using a currency swap to convert the dollars to euros. The company expects
interest rates in both the United States and the euro zone to fall.

a. Should the swap be structured with interest paid at a fixed or a floating rate?

b. Should the swap be structured with interest received at a fixed or a floating rate?

Question 2

Alpha and Beta Companies can borrow for a five-year term at the following rates:

a. Calculate the quality spread differential (QSD).

b. Develop an interest rate swap in which both Alpha and Beta have an equal cost savings in their
borrowing costs. Assume Alpha desires floating-rate debt and Beta desires fixed-rate debt. No swap
bank is involved in this transaction.

c. Assuming more realistically that a swap bank is involved as an intermediary. Assume the swap
bank is quoting five-year dollar interest rate swaps at 10.7% - 10.8% against LIBOR flat.

Question 3

Companies X and Y have been offered the following rates per annum on a $5 million 10-year
investment:

Fixed Rate Floating Rate

Company X 8.0% LIBOR
Company Y 8.8% LIBOR

Company X requires a fixed-rate investment; company Y requires a floating-rate investment. Design

a swap that will net a bank, acting as intermediary, 0.2% per annum and will appear equally
attractive to X and Y.
Interest rate and currency swaps

Question 4

Company XYZ has a floating rate borrowing, whose interest rate is LIBOR + 1.5%. The directors are
concerned that the interest rates are going to rise so have approached a bank to discuss entering in
an interest rate swap. The bank has quoted a swap rate of 5% against LIBOR. What is the net interest
XYZ will pay if it enters into the swap agreement? Show your workings.

Question 5

Company A and Company B make an interest rate swap agreement with a nominal value of
$100,000. Company A believes that interest rates are likely to rise over the next couple of years and
aims to obtain exposure to potentially profit from a floating interest rate return that would increase
if interest rates do, indeed, rise.

Company B is currently receiving a floating interest rate return, but is more pessimistic about the
outlook for interest rates, believing it most likely that they will fall over the next 2 years, which
would reduce their interest rate return. Company B is motivated by a desire to secure risk protection
against possible declining rates, in the form of getting the fixed rate return locked in for the period.

The companies then enter into an agreement as follows:

Company A offers Company B a fixed rate of 5% in exchange for receiving a floating rate of LIBOR
rate plus 1%. The current LIBOR rate at the beginning of the agreement is 4%.

a) Assume the interest rate rise and LIBOR increased to 5.25% by the end of the agreement.
Analyse the impact and show your workings of possible profit or loss (if any) incurred by the
companies.

b) Assume the interest rate move in the opposite direction and LIBOR had fallen to 3.75% by the
end of the agreement. Analyse the impact and show your workings of possible profit or loss (if
any) incurred by the companies.