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Sir,
1. In swap, how did 4.6% come ?? I used your method of finding the end result and then do it accordingly. But how did 4.6% come? I am going crazy over thisAlso sir, why is in part c,
Receipt from swap = 1044? I didn’t understand why we are including 715m and 329m here?
And how is predicted exchange rate at year 3 $7.6046 = €1
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Hi Tasnuva,
1. the 4.6 is the balancing figure. They got a loan of 4%, he wants a Wirtonia loan.
Had he not gone with the swap, he would have paid BR + 0.6%.
With the swap, he got 1.2% benefits, so he would get an implied rate of BR +0.6% -1.2%
= BR -0.6%.So, he got a loan of 4% but he wants a loan of BR – 0.6, so he buys BR and sells 4.6%.
Hope that helps
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Hi Tasnuva,
For part c
So we got told the swap will happen.
As it is a currency swap, in addition to the interest rate exchange, you are actually borrowing in the foreign currency. In doing so, you are fixing the spot rate for today to 3 years time.
“The swap would be for the initial fee paid for the franchise, with a swap of principal immediately and in three years’ time, both these swaps being at today’s spot rate.”
Therefore, the initial $5000 will be borrowed and paid in 3 years time at today spot rate of €0.1430 = $1.
We had received $7,000, $5,000 will be used for paying off the borrowing at therefore today spot rate and $2,000 will be at the spot rate in 3 years time.
Using the purchasing power parity formula to calculate exchange rates:
S1 = S0 x (1 + hc)/(1 + hb)
Year
1 2 3
0·1430 x 0·1472 x 0·1417 x
1·06/1·03 1·04/1·08 1·03/1·11
= 0·1472 = 0·1417 = 0·1315
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