I am a national banker, who has approached two of my multi-national clients to offer to construct a currency swap that will enable both parties to better manage interest rate and Forex risk exposures.
Company A has borrowed $20 million and Company B has borrowed GBP 11 million. Each wishes to swap in the others currency. The current spot exchange rate is GBP/$ 2.800.
In the Debt markets, the interest rates are as follows:
Co. A Co. B
$ (fixed rate) 9.3% 9.7%
GBP (fixed rate) 8.1% 8.8%
Any gain obtained from the swap will be split evenly between the companies after the bank has taken its share of 0.1%.
a) Diagramatically, show the initial cash flows associated with the swap
b) Diagramatically, show the interest rate flows that will occur from the 1st interest payment date
c) At the end of the swap, final interest rates will be exchanged and the principal amounts will be re-exchanged. Assume that the spot rate has moved to GBP/$2.65. Digramatically, show all the interest rate flows and principal amt flows that will occur at the swap agreement expiry date.
d) Will either company realise a Forex loss at this time?
This solution assists in computing the value of a currency swap between Company A and Company B.