Consider fixed-for-fixed currency swap. Firm A is a U.S.-basedmultinational. Firm B is a U.K.-based multinational. Firm A wantsto finance a £2 million expansion in Great Britain. Firm B wants tofinance a $4 million expansion in the U.S. The spot exchange rateis £1.00 = $2.00. Firm A can borrow dollars at 10 percent andpounds sterling at 12 percent. Firm B can borrow dollars at 9percent and pounds sterling at 11 percent. Which of the followingswaps is mutually beneficial to each party and meets theirfinancing needs? Neither party should face exchange rate risk.
1. There is no mutually beneficial swap that has neither partyfacing exchange rate risk.
2. Firm A should borrow $4 million in dollars, pay 11 percent inpounds to Firm B, who in turn borrows 2 million pounds and pays 8percent in dollars to A.
3. Firm A should borrow $2 million in dollars, pay 11 percent inpounds to Firm B, who in turn borrows 4 million pounds and pays 8percent in dollars to A.
4. Firm A should borrow $4 million in dollars, pay 11 percent inpounds to Firm B, who in turn borrows 2 million pounds and pays 10percent in dollars to A.
