la) Under the terms of a currency swap, a company has agreed to receive a fixed interest rate of 10% per annum on an American dollar loan with a notional principal of $5 million. In exchange, the company will pay a fixed interest rate of 8% per annum on a Dutch Euro Loan with a notional principal of 62.5 million. Net interest payments are exchanged every six months. The swap has a remaining life of thirteen months. The current interest rates are 7% per annum in America and 6% per annum in Holland. Assume both rates are with continuous compounding for all maturities (Assuming a flat terms structure). The current exchange rate is 61 = $2. Calculate the current value of the currency swap for the company in American dollars. 10 Marks b) If investors perceive greater interest rate risk, what will happen to equilibrium interest rate in the bond market? Explain using the bond demand and supply framework. 2 Marks c) How will a decrease in the federal government's budget deficit affect the equilibrium interest rate in the bond market? Explain using the bond demand and supply framework. 2 Marks d) What is the expected return on a bond if the return is 9% two-thirds of the time and 3% one- third of the time? What is the standard deviation of the returns on this bond? Would you prefer this bond or one with an identical expected return and a standard deviation of 4.5? Why? 4 Marks e) Identify and describe three factors that cause the supply curve for bonds to shift. 2 Marks 2a) You have been appointed the chief financial officer of McCqueens hotels international and you purchase a large quantity of coffee each month. You are concerned about the price of coffee one month from the day you were appointed. You want to guarantee that you will not pay more than $1.50 per pound for 35,000 pounds. You do not want to pay for insurance but you do want to lock in a price of $1.50 per pound for 35,000 pounds. i) Show the economics of a futures transaction if the spot price on the delivery date is $1.25, $1.50 or $1.75. 3 Marks ii) What is the variability of McCqueens hotels international total outlays under the futures contract? 2 Marks iii) If at the time of delivery coffee is $1.25 per pound, should you have forgone entering into the futures contract? Why or why not? 3 Marks b) You are the finance officer of a large Municipality in your country and you are investing in cattle futures. You purchase futures contracts worth 400,000 pounds of cattle with an exercise price of $0.60 per pound and an expiration date in one month
