Exam 14: Interest Rate and Currency Swaps

An interest-only currency swap has a remaining life of 18 months.It involves exchanging interest at 14% on £20 million for interest at 10% on $14 million once a year.The term structure of interest rates is currently flat in both the U.S.and in the U.K.If the swap were negotiated today the interest rates exchanged would be $8% and £11%.All rates were quoted with annual compounding.The current exchange rate is $1.95 = £1.What is the value of the swap to the party paying dollars?

Company X and company Y have mirror-image financing needs (they both want to borrow equivalent amounts for the same amount of time.Company X has a AAA credit rating,but company Y's credit standing is considerably lower.

Floating for floating currency swaps

Come up with a swap (principal + interest)for two parties A and B who have the following borrowing opportunities. \% \ 8\% +1/2\% \ 8.20\% The current exchange rate is $1.60 = €1.00.Company "A" wishes to borrow $1,000,000 for 5 years and "B" wants to borrow €625,000 for 5 years.You are a swap dealer.Quote A and B a swap that makes money for all parties and eliminates exchange rate risk for both A and B.Firms A and B are more concerned with what currency that they borrow in than whether the debt is fixed or floating.

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

A swap bank has identified two companies with mirror-image financing needs (they both want to borrow equivalent amounts for the same amount of time.Company X has agreed to one leg of the swap but company Y is "playing hard to get".

A swap bank makes the following quotes for 5-year swaps and AAA-rated firms:

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. \ £ \ 6\% £5\% \ 7\% £4\% -What are the IRP 1-year and 2-year forward exchange rates?

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. \ £ \ 6\% £5\% \ 7\% £4\% The IRP 1-year and 2-year forward exchange rates are (\ \mid£)== (\ \mid£)== -Explain how this opportunity affects which swap firm B will be willing to participate in.

A major that can be eliminated through a swap is exchange rate risk.

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 below: Fixed-Rate Borrowing Cost Floating-Rate Borrowing Cost Company X 10\% LIBOR Company Y 12\% LIBOR +1.5\% A swap bank proposes the following interest only swap: Y will pay the swap bank annual payments on $10,000,000 with a fixed rate of 9.90%.In exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR - 0.15%; What is the value of this swap to company Y?

When an interest-only swap is established on an amortizing basis

Act as a swap bank and quote bid and ask prices to A and B that are attractive to A and B and promise to make at least 20bp for your firm.

Company X wants to borrow $10,000,000 for 5 years; company Y wants to borrow £5,000,000 for 5 years.The exchange rate is $2 = £1 and is not expected to change over the next 5 years.Their external borrowing opportunities are shown below: \ £ Borrowing Cost Borrowing Cost Company X \ 10\% £10.5\% Company Y \ 12\% £13\% 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 9.80%; in exchange the swap bank will pay to company X interest payments on £5,000,000 at a fixed rate of 10.5%.Y will pay the swap bank interest payments on £5,000,000 at a fixed rate of 12.80% and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of 12%. What is the value of this swap to the swap bank?

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 Company X \ 8\% £7\% Company Y \ 9\% £6\% 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?

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow £5,000,000 fixed for 5 years.The exchange rate is $2 = £1 and is not expected to change over the next 5 years.Their external borrowing opportunities are: \ Borrowing Cost £ Borrowing Cost Company X \ 10\% £10.5\% Company Y \ 12\% £13\% 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?

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 below: Fixed-Rate Borrowing Cost Floating-Rate Borrowing Cost Company X 10\% LIBOR Company Y 12\% LIBOR +1.5\% A swap bank is involved and quotes the following rates five-year dollar interest rate swaps at 10.05%-10.45% against LIBOR flat. Assume company Y has agreed,but company X will only agree to the swap if the bank offers better terms. What are the absolute best terms the bank can offer X,given that it already booked Y?

Suppose the quote for a five-year swap with semiannual payments is 8.50-8.60 percent.This means

Explain how firm B could use the forward exchange markets to redenominate a 2-year €40m 5% euro loan into a 2-year USD-denominated loan.

Explain how this opportunity affects which swap firm A will be willing to participate in.