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Sir is the fixation of rate known as currency swap. In this qs there in interest rate swap and then they are fixing the rate for the principal amount.
I am a little confused at to what exactly is currency swap and are we valuing the swap by finding the NPV?
Thanks in advance
It is the same as an interest rate swap except that because they are swapping into a different currency, the amount swapped needs converting to the other currency at the start of the swap, the interest needs converting because it is being paid in the other currency, and the principal needs converting back at the end of the swap.
Part (b)(i) is therefore just as a normal interest rate swap.
Part (b)(ii) specifically asks the the NPV to evaluate the gain or loss of the arrangement.
Sir I am so sorry but why are we swapping the principal again at the end?
The bank is arranging a swap with the counterparty. The counterparty will take out the loan in $ and burecys in euros and they will swap principal immeditely. But what are they swapping again in 3 years time?
The question specifically says that there will be a swap of the principal immediately and in three years time.
Buryecs works in €’s but needs dollars to invest in Wirtonia. If they were not doing a swap then they would borrow the $’s in Wirtonia at floating and in three years time they would repay the $’s.
Instead they are swapping so that they save interest. So they borrow €’s and swap so they now have the $’s that they need for the investing. At the end of the three years they swap back so that they then have the €’s needed to repay their original borrowing in €’s.
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