A U.S. company plans to raise 70,000,000. It plans to raise this money by issuing dollar denominated bonds and using a currency swap to convert the dollars to euros. The company expects interest rates in both the United States and the euro zone to fall. a. Should the swap be structured with interest paid at a fixed or a floating rate? b. Should the swap be structured with interest received at a fixed or a floating rate?

2. Assume a currency swap in which two counterparties of comparable credit risk each borrow at the best rate available, yet the nominal rate of one counterparty is higher than the other. After the initial principal exchange, is the counterparty that is required to make interest payments at the higher nominal rate at a financial disadvantage to the other in the swap agreement? Explain your thinking.

3. A corporation enters into a five-year interest rate swap in which it agrees to pay a fixed rate of 9.75 percent annually on a notional amount of 15,000,000 and receive LIBOR. As of the second reset date, determine the price of the swap from the corporation's viewpoint assuming that the fixed-rate side of the swap has increased to 10.25 percent.

4. A company based in the United Kingdom has an Italian subsidiary. The subsidiary generates 25,000,000 a year, received in equivalent semiannual installments of 12,500,000. The British company wishes to convert the euro cash flows to pounds twice 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 1.5/. The fixed rate on a plain vanilla currency swap in pounds is 7.5 percent per year, and the fixed rate on a plain vanilla currency swap in euros is 6.5 percent per year. a. Determine the notional principals in euros and pounds for a swap with semiannual payments that will help achieve the objective. b. Determine the semiannual cash flows from this swap.

5. Ashton Bishop is the debt manager for World Telephone, which needs 3.33 billion Euro financing for its operations. Bishop is considering the choice between issuance of debt denominated in: Euros (), or U.S. dollars, accompanied by a combined interest rate and currency swap. a. Explain one risk World would assume by entering into the combined interest rate and currency swap. Bishop believes that issuing the U.S.-dollar debt and entering into the swap can lower World's cost of debt by 45 basis points. Immediately after selling the debt issue, World would swap the U.S. dollar payments for Euro payments throughout the maturity of the debt. She assumes a constant currency exchange rate throughout the tenor of the swap. Exhibit 1 gives details for the two alternative debt issues. Exhibit 2 provides current information about spot currency exchange rates and the 3-year tenor Euro/U.S. Dollar currency and interest rate swap.

b. Show the notional principal and interest payment cash flows of the combined interest rate and currency swap. Note: Your response should show both the correct currency ($ or ) and amount for each cash flow. Answer problem b in the template provided. c. State whether or not World would reduce its borrowing cost by issuing the debt denominated in U.S. dollars, accompanied by the combined interest rate and currency swap. Justify your response with one reason.

6. The Centralia Corporation is a U.S. manufacturer of small kitchen electrical appliances. It has decided to construct a wholly owned manufacturing facility in Zaragoza, Spain, to manufacture microwave ovens for sale in the European Union. The plant is expected to cost 5,500,000, and to take about one year to complete. The plant is to be financed over its economic life of eight years. The borrowing capacity created by this capital expenditure is $2,900,000; the remainder of the plant will be equity financed. Centralia is not well known in the Spanish or international bond market; consequently, it would have to pay 7 percent per annum to borrow euros, whereas the normal borrowing rate in the euro zone for well-known firms of equivalent risk is 6 percent. Alternatively, Centralia can borrow dollars in the U.S. at a rate of 8 percent.

Suppose a Spanish MNC has a mirror-image situation and needs $2,900,000 to finance a capital expenditure of one of its U.S. subsidiaries. It finds that it must pay a 9 percent fixed rate in the United States for dollars, whereas it can borrow euros at 6 percent. The exchange rate has been forecast to be $1.33/ in one year. Set up a currency swap that will benefit each counterparty.

7 )Suppose a Spanish MNC has a mirror-image situation and needs $2,900,000 to finance a capital expenditure of one of its U.S. subsidiaries. It finds that it must pay a 9 percent fixed rate in the United States for dollars, whereas it can borrow euros at 6 percent. The exchange rate has been forecast to be $1.33/ in one year. Set up a currency swap that will benefit each counterparty.

8) Suppose that one year after the inception of the currency swap between Centralia and the Spanish MNC, the U.S. dollar fixed-rate has fallen from 8 to 6 percent and the euro zone fixed-rate for euros has fallen from 6 to 5.50 percent. In both dollars and euros, determine the market value of the swap if the exchange rate is $1.3343/..

Section b.

Q2. Mnudell-Flcming model. {ill marks} Consider an open economy lS-Llyl model. lChina's currency is the \"Chinese Yuan Remninhi {CNY}\" and the USA? currency is the \"US dollar WED)". China has a xed exchange rate regime with respect to USE. The central bank of China maintains a peg of l CNY=D.14 USD. The interest rate in the USA is 1.5%. a. What do the above facts imply about the interest rate in China? Explain. {2 points} b. Suppose that the USA experiences an increase in output 1'". With the help of a diagram explain the short-run effects of the increase in l" on the economy of China. What happens to output and net exports? Carefully label your diagram. {2 points] c. Suppose the USA Federal Reserve Bank conducts an expansionary monetary policy and lowers its interest rate to 2%. How will the central bank of China react if it wants to maintain the exchange rate peg? What will he the effect of this on the interest rate in China? {2 points} d. Following part (c), widt the help of a diagram explain the short-rim effects of the foreign expansionary monetary policy on the economy of China. What happens to output and net exports? {2 points] e. Suppose instead that China decides to abandon the fixed exchange rate regime and to adopt a exible exchange rate regime. With the help of a diagram explain how your answers in part {b} would change? What would happen to output, net exports, and nominal exchange rate? (2 points} 3. (55 points) The inverse demand function a monopoly faces is P = 100 -Q. The firm's cost curve is TC(Q) = 10+5Q (a) (4 points) What is the monopolist's marginal revenue curve? (b) (3 points) What is the monopolist's marginal cost curve? (c) (4 points) What level of output maximizes the monopolist's profits? (d) (4 points) What is the price charged by a profit maximizing monopolist? (e) (4 points) How would your answers to parts (a)- (d) change if TC(Q) = 100 +5Q? (f) (4 points) For what value of fixed costs, does the monopolist break even? (g) (4 points) For what value of fixed costs, would be monopolist find it optimal to shut down in the short-run? (h) (4 points) For what value of fixed costs, would be monopolist find it optimal to shut down in the long-run? (i) (4 points) What is the value of Lerner Index at the profit maximizing level of output