Let's walk through a practical example of how a cross currency swap can be used in funding decisions. Imagine a UK investment grade issuer looking to raise 100 million pounds in five year funding. The issuer has two options issuing in US dollars at SOFR plus 74 basis points, or issuing in pounds at SONIA plus 64 basis points. At first glance, it might seem like issuing in pounds is the cheaper option, but to properly compare, we need to calculate the effective spread over GBP swaps if the issuer were to issue in US dollars and swap it back into pounds. If the issuer chooses the US dollar issuance, they will raise funds from a US dollar bond investor at SOFR plus 74 basis points. However, since they funding needs on pounds, they will enter into a cross currency swap with a bank. In the swap, the bank will pay SOFR plus 74 basis points on the US dollar leg while the issuer will pay the bank SONIA plus a spread on the GBP leg. The key question becomes what spread over SONIA does the issuer have to pay to keep the swap present value neutral? A standard cross currency basis swap ensures that the exchange of SOFR and SONIA reflects real market conditions. At the time of this example, the five year pound dollar basis swap was trading at minus 17.25 basis points. This means that in a standard cross currency swap, the bank would pay SOFR flat on the US dollar leg while receiving SONIA minus 17.25 basis points from the issuer. However, the issuer needs to receive SOFR plus 74 basis points, as they are also looking to receive the credit spread over SOFR that was determined at bond issuance.

So the bank adds 74 basis points on the US dollar leg and pay SOFR plus 74. However, for the swap to be present value neutral, the issuer must pay a spread on the GBP leg that offsets these terms. Would the spread on the GBP leg also be 74 basis points? Not quite. What we have to keep in mind is that basis points in different currencies are not always directly comparable due to interest rate differentials. Since one basis point in US dollars is not equal to one basis point in pounds, we need to apply a conversion factor. At the time, this example was created, the pound dollar traded at 1.25 in the spot market. One basis point in US dollars represented 57,742 US dollars, or 46,193 pounds when translated into pounds. Meanwhile, one basis point in pounds represented 46,646 pounds. This means that one basis point in US dollars did not equal one basis point in pounds. More precisely one basis point in US dollars was equal to 0.9903 basis points in pounds.

To ensure that the swap remains present value neutral, we apply this conversion factor to determine the appropriate adjustment on the GBP leg. Since 74 basis points have been added to the US dollar leg, we multiply 74 by 0.9903, which results in an addition of 73.28 basis points to the GBP league. Since the market rate for the GBP league was SONIA minus 17.25 basis points, adding 73.28 basis points brings the effective funding level to SONIA plus 56.03 basis points.

Now that we have the effective GBP spread, let's compare the two options. Issuing directly in pounds would cost SONIA plus 64 basis points while issuing in US dollars and swapping two pounds. Results in SONIA plus 56.03 basis points. Since SONIA plus 56.03 basis points is lower than SONIA plus 64 basis points, the US dollar issuance plus the cross currency swap is the cheaper option when swapped back into pounds.

This example highlights why issuers consider cross currency swaps in funding decisions. By issuing in US dollars and swapping to pounds, the issuer achieves a lower funding cost, than issuing directly in pounds. This was possible because the FX basis traded at a negative level, effectively reducing the cost of swapping US dollar funding into pounds. Cross currency swaps allow market participants to take advantage of more favorable funding conditions in different currencies while managing FX risk effectively. That's why they are widely used by corporates and financial institutions seeking optimal funding strategies.