The Centralia Corporation is a Canadian manufacturer of small kitchen electrical appliances. It has decided to construct a wholly owned manufacturing facility in Zaragoza, Spain, to manufacture microwave ovens for sale to the European Union market. The plan is expected to cost 5,000,000 and to take about one year to complete. The plant is to be financed over its economic life of eight years. The borrowing capacity created by this capital expenditure is $2,000,000; the remainder of the plant will be equity-financed. Centralia is not well known in the Spanish or international bond market; consequently, it would have to pay 7% per annum to borrow euros, whereas the normal borrowing rate in the Eurozone for well-known firms of equivalent risk is 5%. Centralia could borrow dollars in Canada at a rate of 6%.

a)Suppose a European MNC has a mirror-image situation and needs $2,000,000 to finance a capital expenditure in Canada. It finds that it must pay a 7% fixed rate for dollars, whereas it can borrow euros at 5%. The exchange rate has been forecast to be $1.5/ in one year. Set up a currency swap that will benefit each counterparty.

b)Suppose that one year after the inception of the currency swap between Centralia and the Spanish MNC, the dollar fixed rate has fallen from 6% to 5% and the Eurozone fixed rate for euros has fallen from 5% to 3.5%. In both dollars and euros, determine the market value of the swap if the exchange rate is $1.51/.