1) You have been provided with the following information on a fixed-fixed USD-GBP currency swap, the spot exchange rate between USD and GBP, and the yield curves for USD and GBP:
- Two-year fixed-fixed currency swap of USD 2.5% for GBP 4.25% based on a notional principal of USD 5,000,000
- Spot exchange rate of GBP 1 = USD 1.5035
- The yield curves for discounting (valuing) cash flows are flat (i.e., the same rate for all relevant maturities) at 1.35% for USD and 3.75% for GBP.
a) What is the implied exchange rate between USD and GBP for the interest payments made under the swap? Should you expect this rate to match the current value of the exchange rate? Explain.
b) Value both sides of the swap. What is the time zero value of the swap to the USD receiver? Does the USD receiver need a settlement payment at the start of the swap to ensure fair value for both parties? Explain.