My understanding IR swaps contradicts with any logic involved in the below Kaplan example. In a swap, with neither firm being given the advantage in the question, why on earth would firm’s enter into a swap and agree to pay interest at the rate they would be able to receive on their own in the foreign market? Would not an acceptable rate be within the bounds of the loan rates, 9%
[Question removed by admin]
Are you sure there is not a mistake in how you presented the question. I don’t have my books now but I remember this exercise and I figured it out. Could you check?
Copyed and pasted right from the book… I am perplexed,If i am right it is not the first error I picked up on in book 5…
w/o swap can raise net cost AA USD 10% BB AUD 8% with swap raises pays to bank gets from swap gain pays to partner net cost AA AUD 7% 8% 1% 10% 9% BB USD 9% 10% 1% 8% 7%
No the question must have been correct. This is what I think the solution is.
Oh gosh this f*king system has not displayed my table right.
So I figured it out:
W/o swap: AA pays 10% for the USD and BB pays 9% for the AUD.
With swap: AA pays this 10% to its partner and BB the 9% to its partner, but both gain 1-1% by doing the following:
AA raises the AUD, pays the bank 7% but gets 8% from BB. Makes 1% gain. Therefore net cost is 10-1=9%.
BB raises the USD pays the bank 9% but gets 10% from AA. Makes 1% gain. Therefore net cost is 9-1=8%.
I think this is the solution. Hope I have not screwed it up because I remember spending hours on it when I studied derivatives.
Thanks on the assist Moosy! Was over thinking this way to much…
Which is why it was removed: you violated Schweser’s copyright.