Problem
For all maturities, the US dollar (USD) interest rate is 4% per annum and the Sterling (£) rate is5% per annum. The current value of the £ is 1.37 USD. In a swap agreement, a financial institution pays 5% per annum in £ and receives 6% per annum in USD. The principals in the two currencies are USD 20 million and £15 million. Payments are exchanged every year, with one exchange having just taken place. The swap will last two more years. What is the value of the swap to the financial institution? Use valuation in terms of bonds. Assume all interest rates are continuously compounded.