6.

A USA company wants to borrow CHF to finance a five-year investment project in

Switzerland. It wants to borrow in CHF because the profits from the project will be in CHF
and so it would like to have CHF debt liabilities in order to hedge its currency exposures.
However, the firm is unknown in Switzerland and could have to pay higher interest rates
than the Swiss companies on the Swiss money market. Assume the company needs to invest
CHF13 million and the current spot rate is USD1= CHF1.30. Evaluate how the US Company
might be able to get around this problem using currency swap.

The company can approach a bank to arrange a currency swap with a counterparty which is a Swiss
company that is able to get cheaper rate in the Swiss money market.

The USA Company can borrow USD 10million in the domestic market. Then, it can exchange the
USD borrowing with those denominated in CHF with the Swiss counterparty. If the USA Company
preferred to borrow in floating rate whereas the Swiss counterparty preferred a fixed rate USD
loan, then the currency swap will operate as follow:

Step 1: Initial exchange of principal

USA company Swiss company (USD principal) (USD 10million @ fixed rate)

Swiss company USA company (CHF principal) (CHF 13million @ floating rate)

Step 2: Exchange of interest payments for next 5 years

USA company Swiss company (CHF floating rate)

Swiss company USA Company (USA fixed rate)

Every 6 months there is an exchange of interest payments, USA company make floating rate
payments of CHF to the Swiss company whereas the Swiss company make fixed rate payments of
USD to the USA Company. So, the USA Company now have debt liabilities denominated in CHF.

Step 3: “Re- exchange” of principal

– On maturity, principal amounts are re-exchanged at the original spot rate

-USA company pays USD 10 million (plus interest rate) to U.S. bank (Slide 31,32)
7) A Malaysian Company has been granted to USD loan for 3 years by an offshore bank
based in Labuan. The purpose of the loan is to finance the purchase of tooling equipment for
expansions of its manufacturing business. The details of the USD loan is as follows:

Amount: USD 10 million

Tenor: 3 years

Start Date: value spot

Cost: 5month over LIBOR+50 basis points

Assumptions:

USD/MYR spot rate:3.8000

Start Date: value spot

Amount: USD 10 million

MYR Equivalent: MYR38 million

Tenor: 3 years

Company pays: 6months KLIBOR+100 basis points

Domestic bank: 6months LIBOR+50 basis points

- As the Malaysian company’s revenue is MYR, the volatility in exchange rates will impact
the cost of servicing the foreign currency loan.

- Illustrate the cash-flow on how the Malaysian Company can hedge tits exposure with a 3-
year cross currency swap with a domestic bank.
ANSWER:

Exchange of principal

- At year 0, Malaysian company takes loan principal of USD 10million from the offshore
bank.

Payment of interest

- At year 1-3, Malaysian company takes the USD 10million and forwards to domestic bank
and then domestic bank give Malaysian company the MYR 38million

- At the end of each year, the Malaysian company make floating rate payments of MYR
KILBOR + 100bp to domestic bank. The domestic bank make fixed rate payments of USD
LIBOR + 50bp to Malaysian company.
Maturity

- Re-exchange principal (slide 32)