On December 15, 2017 you enter a five-year pay-fixed USD, receive-fixed EUR currency swap, paying 2.0 %
Question:
On December 15, 2017 you enter a five-year "pay-fixed USD, receive-fixed EUR" currency swap, paying 2.0 % in USD and receiving 0.25% in EUR, on a face amount of 100 million, with annual reset dates. The current spot exchange rate is 1 EUR=1.20 USD. Suppose the term structure in USD and EUR are flat for all maturities out to 5 years. To simplify computations, assume that the day-count conventions for both the fixed and floating sides are 30/360.
1. Provide the cash flow table, including the dates and amounts of the future cash flows from the swap.
2. If you are USD-based bank, and this is your only currency exposure, explain how you would hedge it? (Explain which instrument you would use, given the available instruments in the market, and why.)
3. Suppose the day after you enter the swap the exchange rate suddenly jumps to 1 EUR = 1.25 USD, but the interest rates remain the same for all maturities. Ignoring the oneday time difference, what is the new five-year swap rate? What is your mark-to-market gain? Think carefully before you calculate. These are not complicated calculations.
4. Assuming that you unwind the swap at the new swap rate, how much do you make or lose from the swap? Explain with calculations, if necessary, how the hedge would work to yield the offsetting cash flow to make the total profit/loss equal to zero.
Spreadsheet Modeling & Decision Analysis A Practical Introduction to Management Science
ISBN: 978-0324656633
5th edition
Authors: Cliff T. Ragsdale