Question

5. Assume the following information about the exchange rate between Cdn. $ and pound sterling £ and quoted annual interest rates on deposits: The current spot exchange rate: Cdn $1.7 per £ The 3-month forward exchange rate: Cdn $1.8 per £ Cdn S-denominated deposit rate = 1.0% per annum £-denominated deposit rate = 1.4% per annum Find net profit (loss) from a spot 3-month forward swap, assuming the swap size of Con $170 million or £ 100 million.

Answer 1

Interest earned in Canada after three months:

Amount= $170 mil

Rate = 1% p.a

Interest = 170*1/100*3/12= $0.0425 mil or $425,000

Interest earned in sterling after three months:

Amount= £100 mil

Rate = 1.4% p.a

Interest = 100*0.014*3/12= £0.35 mil or £350,000

So if this interest amount is converted into $ after 3 months,

3 months forward rate = $1.8/£

So £350000 will be, = 350000*1.8= $630,000

Here due to forward swap, there will be profit of $(630000-425000)= $205,000.