A company based in the United Kingdom has an Italian subsidiary. The subsidiary generates 10,000,000 a year, received annually. The British company wishes to convert the euro cash flows to pounds once a year. It plans to engage in a currency swap in order to lock in the exchange rate at which it can convert the euros to pounds. The current exchange rate is 1.23/. The fixed rate on a plain vanilla 5-year currency swap in pounds is 1.20% per year, and the fixed rate on a plain vanilla 5-year currency swap in euros is 1.00% per year.

a. Determine the notional principals in euros and pounds for a swap with annual payments that will help achieve the objective.

b. Determine the annual cash flows from this swap, and illustrate the cash flows with a swap diagram.

c. Calculate the effective exchange rate at which the payments are swapped.