very short question on currency swaps

It is the ‘missing figure’ to achieve what is wanted from the swap (have you watched my free lectures on swaps?).

Barrow can borrow €’s at E + 1.5%
Greening can borrow $’s at 4.5%
So a total between them of E + 6%

For a swap they borrow in their own currencies (and swap who actually pays the interest).
So Barrow borrows $’s at 3.6%.
Greening borrows €’s at E + 0.8%
So a total between them of E + 4.4%

That means a saving between them of 1.6%, which because they share equally is 0.8% each. Ignoring for the moment then bank changes, then they must both end up paying 0.4% then they would if they borrowed the money themselves.

So the end result for Barrow must be that they pay E + 1.5% – 0.8% = E + 0.7% (plus the bank fee of 0.2%)
The end result for Greening must be that they pay 4.5% – 0.8% = 3.7% (plus the bank fee of 0.2%).

How they achieve this by settling up between them doesn’t really matter – they can agree how they want (and exam questions don’t ask these days). However a common way is for them to pay their own interest, for one to pay the other Euribor, and for the other one to pay fixed interest to the other to get the correct end result.

To illustrate, Barrow must end up paying E + 0.7% (ignoring the bank fee).

However, they borrow fixed at 3.6% and pay E to Greening. So they are then paying E + 3.6%. To end up paying only E + 0.7%, it needs Greening to pay them 2.9% (3.6 – 0.7).

Similarly Greening must end up paying 3.7%. However the borrow floating and pay E + 0.8%. They receive E from Barrow, so they are not paying only 0.8%. To end up paying 3.7% then they need to pay 2.9% to Barrow (3.7 – 0.8)

You are welcome 🙂