Galeplus

And also how do we know that Galeplus wants floating and counterparty wants fixed as given in bpp solution.Thanks

The floating ones are those that are PIBOR + X% (PIBOR is there are the equivalent of LIBOR. That changes from day-to-day (floating) but the rate actually paid by either company obviously is higher depending on their credit rating.) Galeplus is investing in Perdia and so wants to borrow in Perdian currency. However because they are not 'local', they have to pay a higher rate. Similarly, the counterparty has to be a higher fixed rate in the UK, because they are not 'local' to the UK. By borrowing the 'opposite' of what the want (i.e. Gale plus borrowing in GBP and counterparty borrowing in Persia) and then paying each others interest, then in total they end up saving and can share the saving between them. Sorry - there is no lecture on swaps at the moment.

Dear Mr Moffat Would you please help me to understand question Galeplus, part b(iii). It is related to the swaption. Galeplus (UK-Sterling) will invest in Perdia (Rubbit) with it initial costs of 2,000 mil rubbits. Due to very high inflation in Perdia, Galeplus is considering to use a currency swaption for 3 years with the premium of 300k sterling as its alternative hedge. I do not understand why the swaption mention is unwise. As from my thinking the result of the protection is that: Y0: Galeplus receives 2,000 mil rubbits and pays 23.42 mil sterling (at the exchange rate 85.4 rubbits = 1 sterling) Y3: Galeplus receives 2,000 mil rubbits and pays 23.42 mil sterling (same exchange rate above). This means at the end of year 3, Galeplus will receive 23.42 mil sterling and pay premium. Without the swaption, Galeplus will receive 6.9 mil sterling (at worst given inflation rate is 50%) or 15.3 mil sterling (25% inflation). Neither of the results is better than the result from using the swap. Please help me to know where I am wrong. Thank you very much. Hanh

My apologies. Please read Y3: Galeplus pays 2,000 mil rubbits and receives 23.42 mil sterling

You are correct. If the rubbit was to appreciate against the pound then the swaption would not be exercised. However given the relative inflation rates, the rubbit will almost certainly depreciate against the pound, which makes the swaption attractive.

Dear Mr Moffat Thank you Mr Moffat. So the answer from the question "...The payment of 300 000 pound for the swaption's proctection would therefore be unwise" is incorrect? Many thanks Hanh

If that is what the answer in your book says, then it would seem to be the wrong way round (i.e. incorrect).

Thank you very much Mr Moffat.

You are very welcome :-)