Reference no: EM133512395

Case Study: Sri Krishna Industries Limited is an Indian manufacturer of cement-based construction items including sanitaryware. It has a proposal to set up a wholly-owned manufacturing facility in Singapore to cater to the needs of the South East Asian market. A Singapore-based management consultancy firm has prepared the project report, according to which the project is estimated to cost USD 100 million. All the civil works and installation of the machinery can be completed in 12 months. The economic life of the project is estimated at 10 years.

The consultancy firm has suggested that the company opt for foreign debt by issuing Eurobonds of USD 40 million. The remaining cost of the project will be equity financed.

Sri Krishna Industries is a South Indian company and is not well-known even in other parts of India, let alone in foreign markets. Therefore, the company has to offer a premium of at least 2 percent over the coupon rate of 7 percent, which is the borrowing rate for well-known companies of equivalent risk.

At the same time, a Korean MNC has worked out proposals to set up a car manufacturing plant in Southern India. The project cost is estimated at INR 4,500 million with an economic life of 10 years. It finds that it must raise INR 1,800 million by issuing 10 per cent debentures in India, whereas it can borrow U.S.Dollars by issuing Eurobonds at 7 per cent in the European Union market. The spot rate between INR and U.S dollar is INR 44.5. The risk-free interest rate is 8 percent in India and 6 percent in the United States.

Question 1. Set up a currency swap that will benefit each counterparty. How can a bank also be involved in the swapping transaction?

Question 2. Suppose that, after one year of entering the swap contract, the risk-free interest rate in the United States has increased by 50bp, while there is no change in the risk-free interest rate in India. Determine the market value of the swap.