Hull: Currency Swap Table-Comparative Advantage

[mikey10011]

David,

I am using an ancient Hull text and am hoping that he kept the same example on currency swaps.

Specifically he has the following table

Dollars Sterling
Company A 8.0% 11.6%
Company B 10.0% 12.0%

Hull says that "company B has a comparative advantage in the sterling market." Given that company A is charged a *lower* interest rate for both dollars and sterling, why does company B have a comparative advantage? [I know this is basic but this is also Jorian's FRM Handbook Example 9.9 (p. 227) where he answers that "a company can have a comparative advantage in one currency" (p. 236).] I guess a better question is, from the perspective of a currency swap trader what does *comparative advantage* mean?

Thanks!

 

[David Harper CFA FRM]

Hi Mikey,

Here is a prior thread that may be helpful.
I input your assumptions into the same XLS: Please see the third tab on this sheet which illustrates a trade where both companies share equally in the total gain, using your numbers above. (note my example is simpler than Hull's because it omits the intermediary who serves to siphon off a bit of the total gain)

I frankly think the whole topic can be vexing. I just use shortcuts implied by Hull: you simply only need to compare the differences. In this case, dollar market difference = 2% and sterling market difference is 0.4% (i.e., 12% - 11.6%). For practical purposes, that's all you need to do.

* If there is no difference, there is no comparative advantage
* If there is a difference, there is a comparative advantage. Further, BOTH parties have wil have an advantage (see thread re: "less more, more less") and their total advantage equals the difference. In this case, their total advantage = 2%- 0.4% = 1.6%. This is consistent b/c if the difference is 0, there is no advantage to share. In my XLS, the yellow input let's you decide how much to share.

Hope this helps, David