Set 3 Important note: Please use a calculator to perform all numerical computation. This is what you may be required to do on the exam. The list of allowed calculators by the university is here: http://www.exam.hku.hk/pdf/list.of.cal_092022.pdf. Question 1: Basic Concepts on Interest Rate Swaps (1/10) (1) Give three reasons why investors use interest rate swaps. Question 2: Basic Concepts on Other Swaps (1/10) (1) Define what a currency swap is. (2) Explain the difference between currency swaps and foreign exchange swaps. Question 3: Forward Rate Agreement (FRA) (2/10) Suppose you need to pay $1M to finance a project in 3 months. Bank ABC will provide a one year loan with the amount of $1M in 3 months and bank XYZ offers a 3mth15mth FRA with notional value of $1M and forward rate r0, 3mth, 15mth = 10% (simple interest rate). (i) What should you do to fully hedge your borrowing cost (against uncertain spot interest rate)? (ii) Suppose the one year simple interest rate in 3 months rises to 12%. How much money do you owe Bank ABC in 15 months? When and how much money will you pay/receive from bank XYZ? What are your actual cost of borrowing