Question

Axil Corp. has not tapped the Deutsche mark public debt market because of concern about a likely appreciation of that currency and only wishes to be a floating-rate dollar borrower, which it can be at LIBOR + 1%. Bevel Corp. strongly prefers fixed-rate DM debt, but it must pay 1.5% more than the 6.25% coupon that Axil's DM notes would carry. Bevel, however, can obtain Eurodollars at LIBOR + 1/2%. Show work and explain.

1. What is the maximum possible cost savings to Axil from engaging in acurrency swap with Bevel?
2. What is the maximum possible cost savings to Bevel from engaging in acurrency swap with Axil?

Answer 1

1. 2%
2. 2%

Step-by-step explanation:

First step : determine total cost experienced in both cases

Total cost experienced by both firms without swap

= Axil floating dollar cost + Bevel fixed DM cost

= Libor + 1% + 7.75% = Libor + 8.75%

Total cost of funds by both firms when they are involved in a swap

= Bevel Floating dollar cost + Axil fixed Dm cost

= Libor + 0.5% + 6.25%

= Libor + 6.75%

1) the maximum possible cost savings to Axil Corp

Libor + 8.75% - Libor + 6.75% = 2%

2) the maximum possible cost savings to Bevel Corp

Libor + 8.75% - Libor + 6.75% = 2%