Question 2 Southwest Airlines wants to borrow pounds, and BBA Aviation wants to

Question

Question 2 Southwest Airlines wants to borrow pounds, and BBA Aviation wants to borrow dollars. Because Southwest is better known in the US, it can borrow on its own dollars at 7% and pounds at 10%, whereas BBA can borrow dollars at 9% and pounds at 896. Borrower Southwest Airlines (U.S.) BBA Aviation (U.K.) Dollar($)- Denominated Debt 7% 9% Pound(E)- Denominated Debt 10% 8% Suppose Southwest wants to borrow £10 million for two years, BBA wants to borrow $15 million for two years, and the current (S/E) exchange rate is $1.50. Assume the counterparties would exchange principal and interest payments with no rate adjustments A. What swap transaction would accomplish this objective? A) BBA will borrow $15 million for two years and Southwest will borrow £10 million for two years. Then the two companies swap their proceeds and payment streams. B) BBA will borrow dollars at 9% and Southwest will borrow pounds at 10%. Then the two companies will swap the 1% difference in interest rates. C) Southwest will borrow dollars at 7% and BBA will borrow dollars at 9%. Then the two companies will swap the 2% difference in interest payments on dollars. D) Southwest will borrow $15 million for two years and BBA will borrow £10 million for two years. Then the two companies swap their proceeds and payment streams. E) None of the above B. What savings are realized by Southwest Airlines from the swap with BBA Aviation? A) B) C) D) E) 1% or £100,000 annually 2% or £200,000 annually 3% or £300,000 annually 2% or $200,000 annually 1% or $100,000 annually

Explanation / Answer

Part A)

Southwest will borrow $15 million for two years and BBA will borrow £10 million for two years. Then the two companies swap their proceeds and payment streams. (which is Option D)

____

Explanation:

The swap would enable both the companies to obtain money (in their desired currencies) at lower interest rates.Southwest will be able to obtain dollars at a lower rate of interest of 7%. This would provide BBA with a 2% interest rate advantage (as it would have obtained dollars at 9% on its own). Similarly, BBA will be able to borrow pounds at 8% rate of interest. This would provide Southwest with a 2% interest rate advantage (as it would have obtained pounds at 10% rate of interest on its own).

_____

Part b)

The value of savings realized is the difference between the interest rate (10%) at which the requisite amount of pounds could have been obtained by Southwest on its own and the interest rate at which the pounds have been obtained by BBA (8%). The value of net saving for Southwest is determined as below:

Net Savings = Difference in Interest Rate*Amount of Pounds = (10% - 8%)*£10,000,000 = £200,000

Answer is 2% or £200,000 annually (which is Option B)

Related Questions

Navigate

• Browse (All)
• Browse Q
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.