202 CHAPTER 5. USING FORWARDS FOR INTERNATIONAL FINANCIAL MANAGEMENT
Figure 5.9:The Parallell loan – Example 2UKCO USCOSubUKCOSub USCOGBP loanusdloanUSCOwith its subsidiary and view them as economically a single entity—see the
dashed-line box in the figure. Then, there clearly is a reciprocal loan betweenUSCO
andUKII, with a right of offset.
Example 5.27
IfUSCOalso faced capital export controls (for example, Nixon’s “voluntary” and,
later, mandatory controls on foreign direct investment), there would be no way to
exportusdto theukcounterpart. Suppose that there also was aukmultinational
that wanted to lend money to itsussubsidiary, if it were not for the cost of the
investment dollar premium. The parallel loan solves these companies’ joint problem,
as shown in Figure 5.9. (The diagram shows the direction of the initial principal
amounts.)USCOlendsUKCOdollars in theus, without exporting a dime, whileUKCO
lends pounds toUSCO’s subsidiary in theuk(and, therefore, is making no foreign
investment either).
Thus, no money crosses borders, but each firm has achieved its goal. UKCO’s
subsidiary has obtainedusd, andUSCO’s subsidiary has obtainedgbp, and the par-
ents have financed the capital injections. This parallel loan replicates the reciprocal
loan inherent in the short-term swap when we consolidate the parents with their
subsidiaries (see the dashed boxes). In addition, the parallel loan typically has a
right-of-offset clause that limits the potential losses if one of the parties defaults on
its obligations.
Example 5.28
Suppose you have left Zimbabwe, where you lived most of your life, but you are
not allowed to take out the Zimbabwe Dollars you accumulated during your career.
What you can do is try to find someone who, puzzlingly, wants to invest money in
Zimbabwe, and to convince that party to lend his pounds to you in London, while
you undertake to finance his Zimbabwe investment. (One occasionally sees such
proposals in the small-ad sections ofThe Times orThe Economist.) Both parties
would feel far safer if there also is a right-of-offset clause in the loans.
Now that we understand why people may want mutually secured loans, we turn
to the link between these contracts and swaps.