Suppose that the term structure of risk-free interest rates is at in the United States and Australia.

The USD interest rate is 7% per annum and the AUD rate is 9% per annum. The current value of

the AUD is 0.62 USD. Under the terms of a swap agreement, a nancial institution pays 8% per

annum in AUD and receives 4% per annum in USD. The principals in the two currencies are $12

million USD and 20 million AUD. Payments are exchanged every year, with one exchange having

just taken place. The swap will last two more years. Assume all interest rates are continuously

compounded.

(a) (3 points) Draw a diagram to clearly present the cash ow exchange between this nancial

institution and its swap counterparty. Clearly label the currency, interest rate and direction of

cash ow.

(b) (2 points) Suppose the nancial institution had a USD debt before entering the swap. Draw

a diagram to indicate how it may have used this swap contract, to turn the USD debt into a net

AUD debt.

(c) (5 points) What is the current value of the swap in USD to the nancial institution?