Consider two firms, A and B. Firm A isa US-based company and firm B is a Germany-based company. Firm Awants to finance a 10-year, €100 million project in Germany. Firm Bwants to finance a 10-year, $111 million project in the US. Thecurrent spot rate is $1.11/€. Their borrowing opportunities aregiven in the table below:
| US dollar | Euro |
Firm A | 4.00% | 2.70% |
Firm B | 5.00% | 1.80% |
1. Calculate the quality spread differential (QSD) between FirmA and Firm B.
2. Develop a cross-currency interest rate swap in which bothFirm A and Firm B have an equal cost savings in their borrowingcosts, and the swap bank makes 0.30% per annum in arranging theswap and assuming all foreign exchange risks.
3. Illustrate your swap and its cash flows by drawing the properswap diagrams showing the swap interest rates, and the cash flowsat the initiation of the swap, at each annual settlement during thelife of the swap, and at maturity of the swap.
