Japan Airlines International (JAI) issues a fiveyear U.S. dollar−denominated 250 million bond yielding 5 percent. Preferring to keep its liabilities in its domestic currency, JAI immediately swaps the US$-

denominated bond into a yen-denominated bond of matching maturity at the prevailing 2 percent interest rate. The current exchange rate stands at ¥100 =

US$1. One year later, having just made the first coupon swap, the US$/¥ rate appreciates to ¥85 = US$1 and interest rates on five-year notes decline, respectively, to 4 percent in the United States and 1 percent in Japan.

a. What is the value of the currency swap when JAI first contracts it?

b. Detail how the first interest payments are swapped before interest rate and exchange rate changes materialize.

c. How is the market value of the currency swap adjusting to these changes one year later?