Payments in British Pounds

Year 1 = 104,658

Year 2 = 104,658

Year 3 = 104,658

Year 4 = 7,973,658

Receipts in Euros

Year 1 = 26,000

Year 2 = 26,000

Year 3 = 26,000

Year 4 = 10,026,000

Notional Principle of Swap = 10 million Euros

Current Spot Rate: 0.7869 Pounds = 1 Euro

Question 10: After 1 year, Jacob wants to unwind the swap with 3 years remainubg on the sawp. The spot exchange rate has changed to now being 0.8175 Pounds = 1 Euro. The interest rates in Euro are now at a 2 year rate = 1.20% and a 3 year rate of 1.41%. British pound interest rates have risen at a two year rate of 1.44% and a 3 year rate of 1.49%. What is the cost of unwinding the swap after one year has passed (with three years remaining) for Jacob?

Hint: To unwind a currency swap, discount remaining cash flow under the swap agreement at current interest rates, then convert the target currency back to the home currency of the firm.

PV(Cash Flow) = Cash flow in year 2/(1+ Discount Rate)^1 + Cash Flow in year 3/(1+Discount Rate)^2 ..... Cash flow in year n / (1+Discount Rate)^n-2

Cost of Unwinding = PV(Receipts in Euros) - [PV(Payments in Pounds) / Spot Exchange Rate]