Hedging with Swaps and Futures Mocsaro wants to invest in Saudi-Arabia. The company needs 10.0 Mio. SAR (Saudi Arabia Riyal) for the investment. First contacts with Saudi-Arabian Banks brought up that borrowing SAR is possible at a fixed rate of 12%. This is a bit disappointing for the CFO, as borrowing EGP in Egypt is possible at 10%. The following day, the CFO is playing golf with his colleague from Leodre, a Saudi-Arabian company. His colleague totally understands this situation, because Leodre is planning a 15.0 Mio. EGP investment in Egypt, facing a fixed borrowing interest rate of 11%, while the SAR funding in SaudiArabia costs only 9%. When returned to Mocsaro, the CFO has the idea of setting up a currency swap between Mocsaro and Leodre, where both companies should benefit from this situation. You are asked to explain the approach. The spot exchange rate is EGP/SAR = 1.5000. For simplicity, assume that all interest payments are on a yearly basis.

a) Give a graphical description of the transactions necessary for the currency swap (three steps)! Mention all percentages and cash flows! Assume both companies agree on a re-exchange rate equal to the actual spot rate.

b) Show the benefits of the described Swap for both companies, and give a critical comment!

Considering all your calculations, both CFOs finally agree to do the swap. Therefore, the first interest payment is due in one year. To avoid any surprises, the CFO of Mocsaro wants to hedge this interest payment against fluctuations of the EGP/SAR exchange rate by using futures contracts. The following data has been collected:

Futures contract available: SAR/EGP, contract size 125,000 EGP, duration 1 year

• 1 year forward rate: 1.55 EGP/SAR

c) Set up the hedge! Show the effect of the hedge, using exemplary exchange rates of 1.48, or 1.58 EGP/SAR respectively as spot rates in one year! Compare the results with the hypothetical case of not hedging the position!

Hints: You have to find the number of contracts first! Make sure you are contracting the correct futures position! As always, ignore transaction costs and taxes.

Bonus question:

Assume Leodre is planning to get a floating interest rate bank loan. They can lend SAR at (prime rate + 1%), and EGP at (prime rate + 2%). On the other hand, Mocsaro, still interested at a fixed rate credit, could borrow EGP at a floating interest rate of (prime rate + 0.5%). Provide a detailed description of a cross currency interest swap, applying the given data!