The following table shows interest rates companies A and B face for borrowing in either JPY or
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Question:
The following table shows interest rates companies A and B face for borrowing in either JPY or in USD.
JPY USD
A. 6% Libor+0.75%
B. 7.5% Libor+1.25%
Assume that A wishes to borrow in US dollars but B in Japanese Yen.
i. Design a swap contract that is equally beneficial for both counterparties. Assume that the swap dealer requires 50 basis points per annum for their services.
ii. You work as the chief financial officer of a big bank. Working through last year's annual financial statements, you notice an important mismatch between the bank's assets and liabilities. You also notice that your bank usually takes floating-rate deposits and provide fixed-rate loans.Explain how swaps can be used in order to offste this financial risk.
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