March / June 2017 , q3b

Also 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

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

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