On 1 January 2019, Danso Ltd entered into a 3 year cross currency interest rate swap with JP Morgan, a financial institution which specialises in foreign currency swaps. Dayco wishes to receive Euros (EUR) and pay US dollars (USD) through this swap contract. The swap has a notional principal of 7,000,000 EUR. The interest on each currency is to be exchanged at the end of each year.

The current spot exchange rate is 1.1550USD /EUR. The 3 year forward rate is 1.1975USD /EUR. The 3 year fixed rate is 4.5% p.a. for USD and the 3 year fixed rate is 2.9% p.a. for EUR.

The annual swap rate (annual) quoted by JP Morgan for USD and EUR is as below:

Time,USD BidAsk & Eur BidAsk

3 year USD3.42%3.44%, Eur 2.25%2.28%

5 year USD4.32%4.34%, Eur 2.49%2.53%

7 year USD 3.99%4.03%, Eur 1.76%1.79%

For this currency swap the two companies have agreed to exchange the notional principal amounts in USD and EUR as means of collateral on the day the currency swap is signed.

Required:

1. What are the notional principal amounts to be used as collateral in this cross currency interest rate swap?(2 marks)
2. What are the amounts Danso will pay to JP Morgan at the end of each year until the end of the swap?(3 marks)
3. On 1 January 2020, 1 year 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 2 years to maturity. The following quotes were available.

• The spot exchange rate is 1.1710USD /EUR
• The 2 year forward rate is 1.2240USD /EUR
• The 2 year fixed (i.e. discount rate) for USD is 3.1% p.a.
• The 2 year fixed (i.e. discount rate) for EUR is 1.5% p.a.

1. What is the net settlement of unwinding the swap contract for Danso?