Dell Inc. wants to borrow pounds, and Virgin Airlines wants to borrow dollars. Because Dell is better known in the U.S., it can borrow on its own dollars at 7% and pounds at 9%, whereas Virgin can borrow dollars at 8% and pounds at 8.5%
9.a. Suppose Dell wants to borrow £10 million for two years, Virgin wants to borrow $16 million for two years, and the current ($/£) exchange rate is $1.60. What swap transaction would accomplish this objective? Assume the counterparties would exchange principal and interest payments with no rate adjustments.
9.b. What savings are realized by Dell and Virgin?
9.c. Suppose, in fact, that Dell can borrow dollars at 7% and pounds at 9% , whereas Virgin can borrow dollars at 8.75% and pounds at 9.5%. What range of interest rates would make this swap attractive to both parties?
9.d. Based on the scenario in 1.c, suppose Dell borrows dollars at 7% and Virgin borrows pounds at 9.5%. If the parties swap their current proceeds, with Dell paying 8.75% to Virgin for pounds and Virgin paying 7.75% to Dell for dollars, what are the cost savings to each party?
The swap transaction is composed of the following transactions:
Beginning of the swap
Dell pays Virgin $16 million
Virgin pays Dell £10 million
Every interest payment date
Dell pays Virgin £10 million x 8.5% = £850,000
Virgin pays Dell $16 million x 7% = ...
The foreign exchange for current proceeds are determined.