A Five-Year Currency Swap Involves Two AAA Borrowers and Has

Essay

A five-year currency swap involves two AAA borrowers and has been set at current market interest rates. The swap is for US$100 million against AUD 200 million at the current spot exchange rate of AUD/$ 2.00. The interest rates are 4% in U.S. dollars and 7% in Australian dollars, or annual swaps of $4 million for AUD 14 million. A year later, the interest rates have dropped to 3% in U.S. dollars and 6% in Australian dollars, and the exchange rate is now AUD/$ 1.9.
a. What should the market value of the swap be in the secondary market?
Assume now that the swap is instead a currency-interest rate swap whereby the dollar interest is set at LIBOR.
b. What would the market value of the currency-interest rate swap be if these conditions prevailed a year later?