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Unformatted text preview: 5368.1a_HW, 11S FIN 536 – SU Page 1 of 9 Topic 8.1 Interest Rate and Currency Swap Exam Sample Problem 1USE OF SWAP: REDUCE RISK Company ABC currently has a 5year floatingrate loan at £L+1% (of £1M principal) and is concerned about a possible value increase in £ and interest rate. Current exchange rate S = 1.8 $/£. 1.How can company ABC uses swap contracts to hedge the interest rate & currency risk? 2.Suppose that a swap dealer offers the following swap quotes: Year US$ Bid Ask 5 7.25 7.35 Against 6month £LIBOR a)What is the beforeswap borrowing cost for company ABC? b)What is the swap contract for ABC? c)What is the withswap cost for ABC? Exam Sample Problem 1 – Solution 1.Receive £ floating, pay $ fixed. 2.Ans: a)Pay £ L+1% b)Receive £ L and pay $7.35%. c)Pay £ 1%+$7.35% Exam Sample Problem 2USE OF SWAP: REDUCE RISK Company ABC currently has a 5year fixedrate loan at $8% (of $1M principal) and is concerned about a possible decrease in interest rate. 1.How can company ABC uses swap contracts to hedge the interest rate risk? 2.Suppose that a swap dealer offers the following swap quotes: Year US$ Bid Ask 5 7.25 7.35 Against 1year $LIBOR a)What is the beforeswap borrowing cost for company ABC? b)What is the swap contract for ABC? c)What is the withswap cost for ABC? d)Assume L is 5% for the first year. What is the CF involved in the swap contract? What is ABC’s final borrowing cost? Explain how ABC obtains its final borrowing cost. e)Assume L is 9% for the first year. What is the CF involved in the swap contract? What is ABC’s final borrowing cost? Explain how ABC obtains its final borrowing cost. Exam Sample Problem 2 – Solution 1.Receive fix, pay floating 2.Ans: a)Pay $8% b)Receive $7.25%, Pay $L c)Pay $L+0.75% d)Borrow (pay) $8% in the capital mkt, Gain (receive) $2.25% in the swap mkt, pay $5.75% in total cost (=L+0.75%).e)Borrow (pay) $8% in the capital mkt, Lose (pay) $1.75% in the swap mkt, pay a total cost of $9.75% (=L+0.75%). 5368.1a_HW, 11S FIN 536 – SU Page 2 of 9 Exam Sample Problem 3USE OF SWAP: REDUCE RISK Company ABC currently has a 5year fixedrate loan at £9% (of £1M principal) and is concerned about a possible value increase in £ and interest rate. Current exchange rate S = 1.8 $/£. 1.How can company ABC uses swap contracts to hedge the interest rate & currency risk? 2.Suppose that a swap dealer offers the following swap quotes: Year £ US$ Bid Ask Bid Ask 5 8.00 8.10 6.45 6.65 a)What is the beforeswap borrowing cost for company ABC? b)What is the swap contract for ABC? c)What is the withswap cost for ABC? Exam Sample Problem 3 – Solution 1.Receive £ fixed, pay $ fixed. 2.Ans: a)Pay £ 9% b)Receive £8% and pay $6.65%....
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This note was uploaded on 11/07/2011 for the course FIN 536 taught by Professor Staff during the Spring '11 term at S.F. State.
 Spring '11
 Staff
 Interest, Interest Rate, International Finance

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