Its not just oil prices that have been on the move lately. The differential effects of COVID19 on difference countries has 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

27 months (2.25 years) ago, your institution entered into a threeyear crosscurrency interest rate swap with a British aviation company. The swap agreement was overthecounter with the following terms: your institution is to pay 2.95% per annum (with semiannual compounding) in GBP and receive 6month LIBOR + 0.75% per annum in AUD. Payments are semi annual and on a notional principal of AUD20 million. The 6month LIBOR rate and the spot exchange rate at various dates over the last 27 months are shown in the table below:

date of observation	6-month LIBOR rate observed	spot exchange rate observed (AUS for 1 GBP)
t=0	2.87%	1.7462
t=6months	2.38%	1.7764
t=12 months	1.92%	1.9424
t=18 months	0.43%	1.8241
t=24 months	0.26%	1.7685
t=27 months	0.2%	1.7918

(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) Unfortunately for you and your institution, the counterparty to the swap (the British aviation company) has just filed for bankruptcy with 9 months remaining on the swap agreement. Determine the current value of the swap agreement (and ultimately the cost) to your institution. You should assume that the current interest rate is 1.75% per annum in AUD and 1.25% per annum in GBP (with continuous compounding) for all maturities.

The Futures Position (c) Worried about a volatile exchange rate, nine months ago your institution also entered

into a short position in 1.5year currency futures contracts on GBP10 million. At the time, the interest rate was 1.15% per annum in AUD and 0.95% 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 nine months ago? ii. If we closed out the position today, what would be the profit/loss on the futures

transaction?