Question 1 Swaps (16 marks)

(a) Company A wishes to borrow U.S. dollars at a fixed rate of interest. Company B wishes to borrow sterling at a fixed rate of interest. They have been quoted the following rates per annum (adjusted for differential tax effects):

	Sterling	US Dollars
Company A	11.0%	7.0%
Company B	10.6%	6.2%

Required:

(a) Design a swap that will net a bank, acting as intermediary, 10 basis points per annum and that will produce a gain of 15 basis points per annum for each of the two companies.

(4 marks)

(b) A bank entered into a two-year currency swap with semi-annual payments 200 days ago by agreeing to swap $1,000,000 for 800,000. The bank agreed to pay an annual fixed rate of 5% (with semi-annual compounding) on the 800,000 and receive a floating rate tied to LIBOR on the $1,000,000. Current LIBOR and Euribor rates and present value factors are shown in the following table (LIBOR and Euribor are continuously compounding rates).

	Rates (p.a)
160-day LIBOR	4%
180-day LIBOR	4.4%
340-day LIBOR	4.8%
520-day LIBOR	5.2%
160-day Euribor	5.2%
180-day Euribor	5.6%
340-day Euribor	6.1%
520-day Euribor	6.3%

The current spot exchange rate is 1USD = 0.69. 180-day LIBOR at the last payment date was 4.2% p.a. (with semi-annual compounding). Assume that the implied forward rates and the theoretical forward exchange rates can be realized. Also assume there are 360 days in a year.

Required:

Whats the value of the swap to the bank today? Please calculate the value of the swap to the bank in terms of bonds and in terms of forward contracts.

Note: these two methods may yield different results if you use the 4d.p. discount factor given or if you round any number in the calculation. The discrepancy due to rounding errors can be ignored and will be accepted.

(12 marks)

Hint: You may use the following tables to guide your calculations.

Valuation in terms of Bonds

Time	Cash Flow ()	PV Factor	PV ()	Cash Flows ($)	PV Factor	PV ($)
1
2
Total

Valuation in terms of Forwards

Time	Cash Flow ()	Cash Flow ($)	Forward Exch rate	Cash Flow in $	Net Cash Flow ($)	PV Factor	PV ($)
1
2
Total

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