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A Brazilian Software company (KondZilla) plans to expand its business to the U.S. market and requires USD$15 million to fund the expansion. The Brazilian company faces the following borrowing opportunities: obtain a 11.25% Brazilian real (BRL)-denominated loan in Brazil, or a 8.5% USD-denominated loan in the U.S. Meanwhile, a U.S. based minerals extraction company plans to expand its operations to Brazil and requires 60 million BRL to finance its project. The U.S. based company can secure either a 10.75% BRL-denominated loan in Brazil or a 7.5% USD-denominated loan in the U.S.
(a) Which company has an absolute borrowing advantage, which company has a comparative borrowing advantage (and in which market)? Why? Which company would you consider to have a higher credit risk?
(b) As an alternative option to paying fixed rate loans, both companies approach Deutsche Bank,who acts as an intermediary by suggesting to broker a currency swap between the two companies.Essentially, Deutsche Bank engages into a 4-year fixed-for-fixed currency-swap with both companies:
i) The Brazilian company borrows 60 million BRL at 11.25% and swaps it with Deutsche Bank for a $15 million USD loan at 8.25%.
ii) The U.S. based company borrows $15 million USD at 7.5% and swaps it with Deutsche Bank for $60 million BRL at 10.5%.
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