6 EH Xnip E. _l Consider a five year currency swap between two AAA borrowers l_ with payments determined by current market interest rates. The swap is for US$100 million against NZ$ 200 million The current spot exchange rate of 2.00 NZ$/US$. Payments are annual and interest rates are 10% in US$ and 7% in NZ$ Interest payments of US$10m and NZ$14m are exchanged each period. Suppose that a year later interest rates have dropped to 8% in US$ and 6% in NZ$, and the exchange rate is now 1.90 NZ$/US$. What should be the market value of the swap in the secondary market? The new value of the swap can be obtained by considering the market value of two streams of cash flows: A USD bond with 4 years remaining with annual coupon of $10m and a principal of $100m The PV of this bond is $106.62m A NZD bond with 4 years remaining with annual coupon of NZD 14m and a principal of NZD 200m. The PV of this bond is NZD 206.93 The value of the swap in NZD is: Swap (NZD) = 206.93 106.62 x 1.9 = NZD 4.34m W V J l_ The dollar value is 4.34/1.9 = $2.28m