Exam 14: Interest Rate and Currency Swaps

Consider the situation of firm A and firm B.The current exchange rate is $2.00/£ Firm A is a U.S.MNC and wants to borrow £30 million for 2 years.Firm B is a British MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown,both firms have AAA credit ratings. \ £ A \ 6\% £5\% B \7 \% £4\% What are the IRP 1-year and 2-year forward exchange rates?

In an interest-only currency swap

A swap bank

Consider a bank that has entered into a five-year swap on a notational balance of $10,000,000 with a corporate customer who has agreed to pay a fixed payment of 10 percent in exchange for LIBOR.As of the fourth reset date,determine the price of the swap from the bank's point of view assuming that the fixed-rate side of the swap has increased to 11 percent.LIBOR is at 5 percent.

In the swap market,which position potentially carries greater risks,broker or dealer?

With regard to a swap bank acting as a dealer in swap transactions,interest rate risk refers to

Floating-for-floating currency swaps

Consider the situation of firm A and firm B.The current exchange rate is $2.00/£ Firm A is a U.S.MNC and wants to borrow £30 million for 2 years.Firm B is a British MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown,both firms have AAA credit ratings. \ £ A \ 6\% £5\% B \7 \% £4\% The IRP 1-year and 2-year forward exchange rates are $F _ { 1 }$ ($ ∣ £)= $\frac { \$ 2.00 \times ( 1.06 ) } { £ 1.00 \times ( 1.04 ) }$ = $\frac { \$ 2.0385 } { £ 1.00 }$ $F _ { 2 }$ ($ ∣ £)= $\frac { \$ 2.00 \times ( 1.06 ) ^ { 2 } } { £ 1.00 \times ( 1.04 ) ^ { 2 } }$ = $\frac { \$ 2.0777 } { £ 1.00 }$ USD pounds Bid Ask Bid Ask 6\% 6.1\% 4\% 4.1\% Explain how firm A could use the forward exchange markets to redenominate a 2-year $60m 6 percent USD loan into a 2-year pound denominated loan.

Consider the situation of firm A and firm B.The current exchange rate is $2.00/£ Firm A is a U.S.MNC and wants to borrow £30 million for 2 years.Firm B is a British MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown,both firms have AAA credit ratings. \ £ A \ 6\% £5\% B \7 \% £4\% Explain how firm B could use the forward exchange markets to redenominate a 2-year £30m 4 percent pound sterling loan into a 2-year USD-denominated loan.

Consider the dollar- and euro-based borrowing opportunities of companies A and B. borrowing \ borrowing 7\% \ 8\% 6\% \ 9\% A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit.Firm A wants to borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year.The spot exchange rate is $2.00 = €1.00 and the one-year forward rate is given by IRP as $\frac { \$ 2.00 \times ( 1.08 ) } { € 1.00 \times ( 1.06 ) }$ = $\frac { \$ 2.0377 } { € 1.00 }$ . Suppose they agree to the swap shown here.Is this mutually beneficial swap equally fair to both parties?

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown here: Fixed-Rate Floating-Rate Borrowing Cost Bortowing Cost Compary X 10\% LIBOR Compary Y 12\% LIBOR +1.5\% A swap bank proposes the following interest only swap: X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR ? 0.15 percent; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 9.90 percent.What is the value of this swap to company X?

Some of the risks that a swap dealer confronts are "basis risk" and "sovereign risk." Select the definitions that best describe each.

Company X wants to borrow $10,000,000 floating for 1 year; company Y wants to borrow £5,000,000 fixed for 1 year.The spot exchange rate is $2 = £1 and IRP calculates the one-year forward rate as $2.00 × (1.08)/£1.00 × (1.06)= $2.0377/£1.Their external borrowing opportunities are: \Borrowing £Borrowing Cost Cost Compary X \ 8\% £7\% Compary Y \ 9\% £G\% A swap bank wants to design a profitable interest-only fixed-for-fixed currency swap.In order for X and Y to be interested,they can face no exchange rate risk. What must the values of A and B in the graph shown above be in order for the swap to be of interest to firms X and Y?

Consider the borrowing rates for Parties A and B.A wants to finance a $100,000,000 project at a fixed rate.B wants to finance a $100,000,000 project at a floating rate.Both firms want the same maturity,5 years. Firm Fixed Rate Floating A \ 10.3\% Prime +1\% B \ 8.9\% Prime +1/2\% Construct a mutually beneficial interest only swap that makes money for A,B,and the swap bank in equal measure.

Use the following information to calculate the quality spread differential (QSD). Fixed-Rate Borrowirg Floating-Rate BorTownre Cost Cost Compary X 10\% LIBOR Compary Y 12\% LIBOR +1.5\%

A major risk faced by a swap dealer is mismatch risk.This is

Consider the situation of firm A and firm B.The current exchange rate is $1.50/€.Firm A is a U.S.MNC and wants to borrow €40 million for 2 years.Firm B is a French MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown; both firms have AAA credit ratings. \ A \ 7\% 6\% B \8 \% 5\% Show how your proposed swap would work for firm A.(e.g.,if you were acting as an agent for the swap bank,try to "sell" firm A on your swap)

Consider the situation of firm A and firm B.The current exchange rate is $2.00/£ Firm A is a U.S.MNC and wants to borrow £30 million for 2 years.Firm B is a British MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown,both firms have AAA credit ratings. \ £ A \ 6\% £5\% B \7 \% £4\% Show how your proposed swap would work for firm A.(e.g.,if you were acting as an agent for the swap bank,try to "sell" firm A on your swap)

The term interest rate swap

Consider the situation of firm A and firm B.The current exchange rate is $1.50/€.Firm A is a U.S.MNC and wants to borrow €40 million for 2 years.Firm B is a French MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown; both firms have AAA credit ratings. \ A \ 7\% 6\% B \8 \% 50\% What are the IRP 1-year and 2-year forward exchange rates?