DERIVATIVES

Question 2 Grealish Pharma (UK based) has entered into a cross-currency swap to minimise its borrowing costs related to its expansion plans in the US. It was a five-year swap with 100 million being swapped at initiation at the then exchange rate of US$1.40/. The interest rates at inceptions were 4.25% on the UK and 3.50% in the US. After two years the interest rates of the two currency have changed to 5.00% in the UK and 4.00% in the US, while the exchange rate has changed to US$1.50/1. (a) (b) What value has the swap for Grealish? Is the swap an asset or a liability for Grealish? (6 marks) Grealish Pharma has been granted a four-year floating-rate bank loan of 100 million from its main domestic bank. The finance officer is worried about the future interest rates and wants to fix the interest rate of than loan using an interest rate swap. He observed the following annual zero-coupon yield curve: Period 1 2 3 4 Rate (%) 6.00 6.50 7.00 7.25 (c) He is considering a four-year interest rate swap with annual settlement to hedge the 100 million bank loan. Find the at-the-market fixed-rate side of the swap. (7 marks) What will be the fair value of an off-market swap with a four-year remaining maturity per 10,000 nominal that has an annual fixed rate of 6% per cent to the fixed-rate payer? (6 marks) (d) Discuss the forward contracts by explaining their advantages, disadvantages and basics of valuation. Define FRA, ERA and FXA and explain the main purpose of these products and how they might work for a company like Grealish Pharma. (6 marks) Question 2 Grealish Pharma (UK based) has entered into a cross-currency swap to minimise its borrowing costs related to its expansion plans in the US. It was a five-year swap with 100 million being swapped at initiation at the then exchange rate of US$1.40/. The interest rates at inceptions were 4.25% on the UK and 3.50% in the US. After two years the interest rates of the two currency have changed to 5.00% in the UK and 4.00% in the US, while the exchange rate has changed to US$1.50/1. (a) (b) What value has the swap for Grealish? Is the swap an asset or a liability for Grealish? (6 marks) Grealish Pharma has been granted a four-year floating-rate bank loan of 100 million from its main domestic bank. The finance officer is worried about the future interest rates and wants to fix the interest rate of than loan using an interest rate swap. He observed the following annual zero-coupon yield curve: Period 1 2 3 4 Rate (%) 6.00 6.50 7.00 7.25 (c) He is considering a four-year interest rate swap with annual settlement to hedge the 100 million bank loan. Find the at-the-market fixed-rate side of the swap. (7 marks) What will be the fair value of an off-market swap with a four-year remaining maturity per 10,000 nominal that has an annual fixed rate of 6% per cent to the fixed-rate payer? (6 marks) (d) Discuss the forward contracts by explaining their advantages, disadvantages and basics of valuation. Define FRA, ERA and FXA and explain the main purpose of these products and how they might work for a company like Grealish Pharma. (6 marks)