Suppose That the Swap That You Proposed in Question 2

question 45

Essay

Suppose that the swap that you proposed in question 2 is now 4 years old (i.e.there is exactly one year to go on the swap).If the spot exchange rate prevailing in year 4 is $1.8778 = €1 and the 1-year forward exchange rate prevailing in year 4 is $1.95 = €1,what is the value of the swap to the party paying dollars? If the swap were initiated today the correct rates would be as shown: Consider the situation of firm A and firm B.The current exchange rate is $1.50/€.Firm A is a U.S.MNC and wants to borrow €40 million for 2 years.Firm B is a French MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown; both firms have AAA credit ratings.

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Definitions:

Economic Recession

A period of temporary economic decline during which trade and industrial activities are reduced, generally identified by a fall in GDP in two successive quarters.

Inflation

The rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling.

Random Variation

The variability in data that arises due to chance and cannot be attributed to any specific cause or pattern.

Stock Market Prices

The current price at which shares of a company are bought and sold in the stock market.