1. Calculate the Payments on the following Currency Swap providing diagrams where you can:
BB can borrow in the United States for 9%, while AA has to pay 10% to borrow in the United States. AA can borrow in Australia for 7%, while BB has to pay 8% to borrow in Australia. BB will be doing business in Australia and needs AUD, while AA will be doing business in the United States and needs USD. The exchange rate is 2AUD/USD. AA needs USD 1.0 million and BB needs AUD 2.0 million. They decide to borrow funds locally and swap the borrowed funds, charging each other the rate the other party would have paid had they borrowed in the foreign market. The swap period is for five years. Calculate the cash flows for this swap.
2. Use the following data to answer the questions a-d, providing diagrams where you can:
Consider a 3-year annual currency swap that takes place between a foreign firm (FF) with FC currency units and a U.S. firm (USF) with $ currency units. USF is the fixed-rate payer and FF is the floating-rate payer. The fixed interest rate at the initiation of the swap is 7%, and 8% at the end of the swap. The variable rate is 5% currently; 6% at the end of year 1; 8% at the end of year 2 and 7% at the end of year 3. At the beginning of the swap, $1.0 million is exchanged at an exchange rate of FC 2.0 = $1.0. At the end of the swap period, the exchange rate is FC 1.5 = $1.0.
Note: With this currency swap, end-of-period payments are based on beginning of period interest rates.
a. At the initiation of the swap, which party gives the other party and how much?
b. What happens at the end of year 2 with respect to payments?
c. At the termination of the swap, FF gives USF how much in terms of notional amount?
d. At the end of year 3, FF will pay which how much?