Question

Suppose a Spanish MNC has a mirror-image situation and needs $2,900,000 to finance a capital expenditure of one of its U.S. subsidiaries. It finds that it must pay a 9 percent fixed rate in the United States for dollars, whereas it can borrow euros at 6 percent. The exchange rate has been forecast to be $1.33/€1.00 in one year. Set up a currency swap that will benefit each counterparty.

Answer 1

The Spanish MNC can set up a currency swap to benefit both parties in this mirror-image situation. The MNC can borrow euros at 6 percent, convert them to dollars, and lend them to the U.S. subsidiary at a fixed rate of 9 percent. The U.S. subsidiary can then convert the dollars back to euros at the forecasted exchange rate of $1.33/€1.00 in one year, effectively locking in a lower rate.

Step-by-step explanation:

The Spanish MNC can set up a currency swap to benefit both parties in this mirror-image situation. The MNC can borrow euros at 6 percent, convert them to dollars, and lend them to the U.S. subsidiary at a fixed rate of 9 percent. The U.S. subsidiary can then convert the dollars back to euros at the forecasted exchange rate of $1.33/€1.00 in one year, effectively locking in a lower rate. This swap allows the MNC to take advantage of the lower borrowing costs in euros and the U.S. subsidiary to secure a more favorable exchange rate.