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Hi John,
My query is in relation to Buryec Co’s b(ii) that requires us to calculate the NPV of the Currency swap.
My understanding of estimating the value of currency swap was that we would compare CF using the swap rate against CF using forward rate(or future rate) and work out the difference(gain/loss) which will be discounted using the DF.
So the part I did not understand was from year 3 workings where Buryec receives $7,500m back as well as the interest income of $600m from the investment. In here, model answer worked out the receipt of $7500 using the swap rate (for the preagreed amount of $5000m) and future rate for the rest of the amount of $1500 which i understand and is fine.
But when it came to calculating the CF using forward/futures rate, the model answer translated only the income of $600m using future rate and added this amount with the translated figure from above $7500 (instead of taking the difference between swap translated fig and forward rate translated figure). However, i thought we had to translate the $5000 (part of $7500) too using the futures rate so that we could compare the two equivalent euro amounts ($5000 – once using Forward rate and once using swap rate) to work out the gain/loss from the swap from year 3? And, apply the discount factor of 14% to the net value and so on to arrive at the NPV
So, please could you clarify why we did not calculate the future spot value of $7,500 using the swap rate and compared that against the Euro(715+329)?
I hope i made sense and thank you for your help.
Kind regards,
RaiThe exchange rates to be used depend on what is agreed by the parties. There is no standard rule which is why this question states specifically what was agreed.
The question states twice that the swap of the principal (which is $5,000) is to be converted at todays spot rate (0.1430) and therefore all the other flows will be converted at whatever the exchange rates are forecast to be (which is not the same as forward rates – we do not know the forward rates).
Therefore at time 3, the initial principal of $5,000 is converted at the current spot rate of 0.1430, and the remaining $2,500 together with the annual income of $600 are converted at the forecast exchange rate at time 3 of 0.1315.
Hi John,
Sorry, I am not clear yet.
In year 3, i thought we had to calculate the the value of $5000 using the agreed swap rate and the forecast rate too, so that we could work out the gain and loss from using these two rates – that will eventually contribute to the overall calculation of the swap valuation?
Hi John,
I think i understand actually – i confused valuing Currency swap with valuing the gain and loss from currency swap which are two different things.
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