It's not just commodity prices that have been on the move lately. The differential effects of...

 

Transcribed Image Text:

It's not just commodity prices that have been on the move lately. The differential effects of the pandemic and rising inflation in different countries has caused significant movements in exchange rates. Such volatile FX markets increase the need for financial derivatives to hedge such volatility, but it can also increase the counterparty risk involved in such derivative trades. To this end, the financial institution you are working for has a current position in a cross- currency interest rate swap and another SEK (Swedish Krona) currency futures position. Your boss has asked you to evaluate these two positions. The Swap Position 20 months ago, your institution entered into a three-year cross-currency interest rate swap with a Swedish furniture company. The swap agreement was over-the-counter with the following terms: your institution is to pay 3.15% per annum in SEK and receive LIBOR+1.40% per annum in AUD (both rates are semi-annually compounding). Payments are semi-annual and on a notional principal of SEK150 million. The 6-month LIBOR rate and the spot exchange rate at various dates over the last 20 months are shown in the table below: Date of observation t=0 (contract initiation) t = 6 months t = 12 months t = 18 months t = 20 months (today) 6-month LIBOR rate observed 0.14% 0.15% 0.34% 1.98% 2.89% Spot exchange rate observed (AUD for 1 SEK) 0.1594 0.1530 0.1545 0.1430 0.1419 (a) Compute the cash flow paid and received by your financial institution on each payment date of the swap (i.e., at t=0, 6, 12, and 18 months). It's not just commodity prices that have been on the move lately. The differential effects of the pandemic and rising inflation in different countries has caused significant movements in exchange rates. Such volatile FX markets increase the need for financial derivatives to hedge such volatility, but it can also increase the counterparty risk involved in such derivative trades. To this end, the financial institution you are working for has a current position in a cross- currency interest rate swap and another SEK (Swedish Krona) currency futures position. Your boss has asked you to evaluate these two positions. The Swap Position 20 months ago, your institution entered into a three-year cross-currency interest rate swap with a Swedish furniture company. The swap agreement was over-the-counter with the following terms: your institution is to pay 3.15% per annum in SEK and receive LIBOR+1.40% per annum in AUD (both rates are semi-annually compounding). Payments are semi-annual and on a notional principal of SEK150 million. The 6-month LIBOR rate and the spot exchange rate at various dates over the last 20 months are shown in the table below: Date of observation t=0 (contract initiation) t = 6 months t = 12 months t = 18 months t = 20 months (today) 6-month LIBOR rate observed 0.14% 0.15% 0.34% 1.98% 2.89% Spot exchange rate observed (AUD for 1 SEK) 0.1594 0.1530 0.1545 0.1430 0.1419 (a) Compute the cash flow paid and received by your financial institution on each payment date of the swap (i.e., at t=0, 6, 12, and 18 months).

Answer rating: 100% (QA)

To compute the cash flow paid and received by the financial institution on each payment date of the swap we need to calculate the following The SEK in... View the full answer