Exam 14: Interest Rate and Currency Swaps

Nominal differences in currency swaps

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

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 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: A swap bank proposes the following interest-only swap: Company X will pay the swap bank annual payments on $10,000,000 at an interest 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%. If company X takes on the swap, what external actions should they engage in?

Devise a direct swap for A and B that has no swap bank. Show their external borrowing. Answer the problem in the template provided.

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: Design a mutually beneficial interest only swap for X and Y with a notational principal of $10 million by having appropriate values for A = Company X's external borrowing rate B = Company Y's payment to X (rate) C = Company X's payment to Y (rate) D = Company Y's external borrowing rate

Examples of "single-currency interest rate swap" and "cross-currency interest rate swap" are:

Consider the borrowing rates for Parties A andB. 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.

You are the debt manager for a U.S.-based multinational. You need to borrow €100,000,000 for five years. You can either borrow the €100,000,000 directly in Germany or borrow dollars in the U.S. and enter into a combined interest rate and currency swap with a swap bank. One risk that you face by using the swap that you do not face by borrowing euros directly is

Come up with a swap (exchange of interest and principal) for parties A and B who have the following borrowing opportunities. The current exchange rate is $1.60 = €1.00. Company "A" is in Milan, Italy and wishes to borrow $1,000,000 at a floating rate for 5 years and company "B" is a U.S. firm that wants to borrow €625,000 for 5 years at a fixed rate of interest. 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

The term interest rate swap

Pricing a currency swap after inception involves

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: 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%; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 9.90%. Y will pay the swap bank interest payments on $10,000,000 at a fixed rate of 10.30% and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of LIBOR - 0.15%. What is the value of this swap to the swap bank?

Suppose that you are a swap bank and you notice that interest rates on zero coupon bonds are as shown. Develop the 3-year bid price of a dollar swap quoted against flat USD LIBOR. In other words, what you be willing to pay in euro against receiving USD LIBOR?

Which combination of the following represent the risks that a swap dealer confronts: (i) - interest rate risk (ii) - basis risk (iii) - exchange rate risk (iv) - political risk (v) - sovereign risk

FOR YOUR SWAP (the one you have shown above) how would the swap bank quote the swap against prime? (Hint: they are quoting a bid-ask spread against "flat" prime.)

Devise a direct swap for A and B that has no swap bank. Show their external borrowing. Answer the problem in the template provided.

The size of the swap market is

Pricing an interest-only single currency swap after inception involves

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