A firm enters into a 3 year annual fixed for floating euro currency swap at 5% against dollar LIBOR. At inception, the firm pays $1,000,000 and receives 800,000. At the end of each year, the firm makes interest payments in euros and receives interest payments in dollars. At maturity, the firm receives $1,000,000 and pays 800,000.
(a) Suppose dollar LIBOR for each of the next three years turns out to be 6%, 6.5%, and 6.2%, respectively. From the firm’s perspective, what is the sequence of cash flows over the life of the swap?
(b) At the end of year, the euro interest rate has increased by 1%. A 2 year annual fixed for floating euro currency swap is now quoted at 6% against dollar LIBOR. The expected final spot rate is now ST($/¿) = 1.333. From the firm’s perspective, what is the value of the swap in dollars?