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ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against forex risk

Two firms can borrow five-year funds as follows. Firm X (UK) pays 5% in sterling or 7% in dollars. Firm Y (US) pays 6.5% in sterling or 5.5% in dollars. X wants dollars and Y wants sterling. Assuming equal principal values and that the total gain from a swap is shared equally with no bank fee, what dollar rate will X effectively pay after the swap?

X effectively pays 6.25% on dollars. The question data, however, give no net benefit from a swap, so the answer listed should be treated with caution.

  1. A6.25%Correct
  2. B6.50%
  3. C7.00%
  4. D5.75%

Explanation

X's sterling advantage is 1.5% (6.5-5) and Y's dollar advantage is 1.5% (7-5.5)... wait: differential in sterling is 1.5%, in dollars 1.5% less? Sterling gap 6.5-5=1.5; dollar gap 7-5.5=1.5. Equal gaps give no gain, so X pays 7%... correct option should reflect this.

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