Question

Some time ago, a multinational company entered into a currency swap in which it pays 2.8% on $17 million USD and receives 3.8% on 13 million Euros, both rates are semi-annually compounded. There are three annual payments left, where the first payment is after one year from now, and the current exchange rate of the one Euro is $1.6 USD. If the USD OIS is 2.5% and Euro OIS is 3.5% (both are continuously compounded), what is the value of the swap in GBP to the company? (Write your answer in terms of millions and round to 2 digits. E.g. 10.85 Million) Selected Answer: 34.53 Correct Answer: 2.39 + 0.01 (Million) Response Since payments are made annually and the swap rates are semi- Feedback: annually compounded, you need to convert the rates to be annually compounded (remember the rule: the frequency of compounding must match the frequency of payments). Using the bond valuation method, you calculate the present value of the euro leg of the swap and then calculate the present value of the USD leg of the swap. Convert the sum of the USD leg by dividing it by the Fx rate and get the difference between the cash received and cash paid.

Answer 1

ANSWER-

Annual Payment of Interest in US $ 952000 (5.6% of $17 million)

Annual Receipts of Interest in Euros 988000 (7.6% of 13 million Euros)

Total PV of all 3 years Euro Receipts (taking discount rate of 3.5%) = Euros 2768017

Total PV of all 3 years USD Payments (taking discount rate of 2.5%) = US $ 2718934

Converting US $ 2718934 into Euros (@ exchange rate of 1.6) = Euros 1699334 or 1.6 millions

Net Receipt = Euros 2768017 - Euros 1699334 = Euros 1068683 or 1.06 million