On December 18, 2018, Mr. Federico Farfalle, the Treasurer of the Peripatetic Pizza Investment Management S.p.A. (PPIM) the CFO of a US company, was considering entering into a five-year "pay-fixed USD, receive-fixed EUR" currency swap, paying 4.0 % in USD and receiving 2.0% in EUR, on a face amount of 100 million, with annual reset dates. The current spot exchange rate is 1EUR=1.15 USD. Before discussing the specific quotations with the bankers, he decided to ask his new assistant treasurer, Mr. Michele Manicotti, to do a few calculations of his own based on market data. Mr. Manicotti had recently graduated from the Stern School with excellent grades in all the finance courses, including the difficult course, "Futures and Options." Mr. Manicotti now has to do the analysis. How should he proceed? Assume that the term structures in USD and EUR are flat for all maturities out to 5 years. To simplify computations, assume that the day-count conventions for both the fixed and floating sides are 30/360.

Provide the cash flow table, including the dates and amounts of the future cash flows from the swap. 2) Since PPIM is a USD-based company, and this is your only currency exposure, explain how you would hedge it? (Explain which instrument you would use, given the available instruments in the market, and why.) 3) Suppose the day after PPIM enters the swap the exchange rate suddenly jumps to 1 EUR = 1.20 USD, but the interest rates remain the same for all maturities. 4) Ignoring the one-day time difference, what is the new five-year swap rate? What is PPIM's mark-to-market gain? Think carefully before you calculate. These are not complicated calculations. 5) Assuming that PPIM unwinds the swap at the new swap rate, how much they make or lose from the swap? Explain with calculations, if necessary, how the hedge would work to yield the offsetting cash flow to make the total profit/loss equal to zero.

Answer rating: 100% (QA)

Cash Flow Table The cash flow table for the 5year payfixed USD receivefixed EUR currency swap is as follows YearUSD PaymentsEUR Receipts 1400000020000... View the full answer