On 1 January 2015, Dayco Ltd entered into a 7 year cross currency interest rate swap with JP Morgan, a financial institution which specialises in foreign currency swaps. Dayco wishes to receive UK pounds (GBP) and pay US dollars (USD) through this swap contract. The swap has a notional principal of 6,000,000 GBP. The interest on each currency is to be exchanged at the end of each year. The current spot exchange rate is 1.2615USD /GBP. The 7 year forward rate is 1.2971USD /GBP. The 7 year fixed rate is 2.5% p.a. for USD and the 7 year fixed rate is 1.5% p.a. for GBP. The annual swap rate (annual) quoted by JP Morgan for USD and GBP is as below:

For this currency swap the two companies have agreed to exchange the notional principal amounts in USD and GBP as means of collateral on the day the currency swap is signed. Required: (a) What are the notional principal amounts to be used as collateral in this cross currency interest rate swap? (2 marks) (b) What are the amounts Dayco will pay to JP Morgan at the end of each year until the end of the swap? (3 marks) (c) On 1 January 2021, 6 years after the swap contract was signed, Dayco decides to terminate the swap contract and has asked JP Morgan to unwind the swap. At this point the swap contract has 1 year to maturity. The following quotes were available. The spot exchange rate is 1.3155USD /GBP The 1 year forward rate is 1.3220USD /GBP The 1 year fixed (i.e. discount rate) for USD is 2.1% p.a. The 1 year fixed (i.e. discount rate) for GBP is 1.9% p.a. What is the net settlement of unwinding the swap contract for Dayco?(5 marks) (d) Foreign currency swaps, such as the contract discussed in question (a) to (c), are used to hedge risks, such as interest rate risk. Name and describe one other financial instrument that can be used to hedge against interest rate risk? (3 marks)

USD GBP Time Bid Ask Bid Ask 3 year 1.51% 1.55% 0.89% 0.94% 5 year 1.33% 1.39% 1.01% 1.05% 7 year 1.99% 2.03% 0.26% 0.31% USD GBP Time Bid Ask Bid Ask 3 year 1.51% 1.55% 0.89% 0.94% 5 year 1.33% 1.39% 1.01% 1.05% 7 year 1.99% 2.03% 0.26% 0.31%