Question 2: Currency Swap Valuation (12 marks) A Christchurch-based financial institution, as part of diversification of its international cash flows, has decided to enter a currency swap. In the swap agreement, the financial institution pays 2.5% per annum in NZD and receives 1.5% per annum in USD. The principals in the two currencies are 60 million USD and 90 million NZD. Payments are exchanged every year, with one exchange having just taken place. The swap will last 4 more years and current exchange rate is 0.72 USD per NZD. Assume all interest rates are continuously compounded. The hypothetical yield curve for New Zealand and United States are given in the graph: 4.50% 4.00% 3.50% 4.00% 3.00% 3.50% 2.50% 3.00% 2.00% 1.50% 2.00% 2.00% 1.00% 1.50% 1.00% 0.50% 0.50% 0.00% 2y 3y 4y --Yield curve NZD -Yield curve USD Required: a) Find the value of swap (in USD) from the perspective of the financial institution using bond methodology and briefly explain the idea of the approach. (3 marks) b) Find the value of the swap (in USD) using forward contracts methodology and briefly explain the idea of the approach. (3 marks) 1y Question 2: Currency Swap Valuation (12 marks) A Christchurch-based financial institution, as part of diversification of its international cash flows, has decided to enter a currency swap. In the swap agreement, the financial institution pays 2.5% per annum in NZD and receives 1.5% per annum in USD. The principals in the two currencies are 60 million USD and 90 million NZD. Payments are exchanged every year, with one exchange having just taken place. The swap will last 4 more years and current exchange rate is 0.72 USD per NZD. Assume all interest rates are continuously compounded. The hypothetical yield curve for New Zealand and United States are given in the graph: 4.50% 4.00% 3.50% 4.00% 3.00% 3.50% 2.50% 3.00% 2.00% 1.50% 2.00% 2.00% 1.00% 1.50% 1.00% 0.50% 0.50% 0.00% 2y 3y 4y --Yield curve NZD -Yield curve USD Required: a) Find the value of swap (in USD) from the perspective of the financial institution using bond methodology and briefly explain the idea of the approach. (3 marks) b) Find the value of the swap (in USD) using forward contracts methodology and briefly explain the idea of the approach. (3 marks) 1y