It's not just commodity prices that have been on the move lately. The differential effects of

COVID$-19$ on different countries have caused significant movements in exchange rates. Such

volatile FX markets increase the need for financial derivatives to hedge such volatility, but it

can also increase the counterparty risk involved in such derivative trades.

To this end, the financial institution you are working for has a current position in a cross$-$

currency interest rate swap and another GBP $($British pounds$)$ currency futures position. Your

boss has asked you to evaluate these two positions.

The Swap Position

$24$ months ago, your institution entered into a two$-$year cross$-$currency interest rate swap

with a British aviation company. The swap agreement was over$-$the$-$counter with the

following terms: your institution is to pay $4\mathrm{.}70\%$ per annum $($with semi$-$annual

compounding$)$ in GBP and receive $6-$month LIBOR $+0\mathrm{.}60\%$ per annum in AUD. Payments are

semi$-$annual and on a notional principal of AUD$80$ million. The $6-$month LIBOR rate and the

spot exchange rate at various dates over the last $24$ months are shown in the table below:

$($a$)$ Compute the cash flow paid and received by your financial institution on each payment

date of the swap $($i$.$e$.,$ at $t=0,6,12,18$ and $24$ months$).$

$($b$)$ You assume that the counterparty to the swap $($the British aviation company$)$ has just filed

for bankruptcy with $11$ months remaining on the swap agreement. You also assume that

at the time of the bankruptcy the interest rate was $5\mathrm{.}05\%$ per annum in AUD and $4\mathrm{.}72\%$

per annum in GBP $($with continuous compounding$)$ for all maturities and the exchange

rate was $1\mathrm{.}875$ AUD for $1GBP.$ Determine the value of the swap agreement to your

institution at the time of the bankruptcy. Would your institution lose when the aviation

company filed for bankruptcy?

The Futures Position

$($c$)$ Worried about a volatile exchange rate, $12$ months ago your institution also entered a

long position in $1\mathrm{.}5-$year currency futures contracts on GBP$50$ million. At the time, the

interest rate was $5\mathrm{.}15\%$ per annum in AUD and $4\mathrm{.}75\%$ per annum in GBP $($with continuous

compounding$)$ for all maturities. Your boss asks you the following questions:

i$.$ What was the value of the futures position $12$ months ago?

ii$.$ If we closed out the position today, what would be the profit$/$loss on the futures

transaction? The interest rate today is $5\mathrm{.}35\%$ per annum in AUD and $4\mathrm{.}15\%$ per

annum in GBP $($with continuous compounding$)$ for all maturities.