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Currency Swap[25 POINTS]

The music company Spotifywants to raise USD for its American operations while the app Summly wants to raise EUR for its European operations. Spotifyneeds $10 million for 5 years and Summly needs €8 million for 5 years. The Spot($/€) rate is 1.25$/€ and the interest rates that they face on their own are

	Borrowing in USD	Borrowing in EUR
Spotify	2% fixed in Euro-$ market	2.5% fixed in € money-market
Summly	1.5% fixed in $ money-market	3% fixed in Euro-€ market

An intermediary bank can set up a currency swap for the two companies but it will

Pay a 1.25% deposit rate on the $ and charge 1.75% loan rate on the $

Pay a 2.25% deposit rate on the € and charge 2.75% loan rate on the €

Write the 0–5 year cashflows for the $ debt and for the € debt that the bank receives as well as pays. [12 points]

By the end of two years, the new Spot rate is $1.35/€, and the interest rates have fallen such that the bank will:

Pay a 1% deposit rate on the $ and charge 1.5% loan rate on the $

Pay a 2% deposit rate on the € and charge 2.5% loan rate on the €

How much would the two companies be willing to pay/receive from the bank at the end of t=2, if they want to unwind the swap and walk away from their obligations with a t=2 payment? [13 points]

Futures [25 points]

Futures on Euros are sold in bundles of €62,500. Suppose you entered into a Futures contract yesterday to buy €62,500 at $1.31/€ and the price closes today at $1.36. How much have you made/lost? [5 points]

Yesterday, you entered into a futures contract to buy €62,500 at $1.30 per €. Your initial margin account is $2,000 and your maintenance (threshold) level is $1,500. At what settlement price will you get a “margin call” (i.e., a demand for additional funds to be posted)? [5 points]

Yesterday, you entered into a futures contract to sell €62,500 at $1.30 per €. Your initial margin account is $2,000 and your maintenance (threshold) level is $1,500. At what settlement price will you get a “margin call” (i.e., a demand for additional funds to be posted)? [5 points]

Today’s settlement price on a Chicago Mercantile Exchange (CME) Yen futures contract is $1.20/¥100, and the contractual size of one CME Yen contract is ¥12,500,000. Your margin account currently has a balance of $2,000. The next three days’ settlement prices are $1.28/¥100, $1.23/¥100, and $1.18/¥100. If you have along position in one Futures contract, then how much would the balance of the margin account be at the end of: first day, second day, and third day? [3 x 2 points]

If the S($/€) = 1.3250 and the monthly interest rates are r_$ = 0.5% and r_€ = 1.0%, then what would be the current trading price of a 3-month Future on the EUR? [4 points]

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Related Services

Money -Market Hedge [25 POINTS]

Ford Motor Co. buys steel from Posco of Korea, one of the leading steel companies in the world. Say, Ford is billed 1.75 billion Korean Won (KRW) for the steel, and the payment is due in 6 months. Suppose that the Spot rate is KRW1100/USD and 6-month Forward rate is KRW1113/USD, and the annual interest rates are r_USD = 5% and r_KRW = 7.5%.

How would Ford hedge this risk with a Money Market Hedge? Explain all the steps involved in the hedge, clearly identify what you are doing (what are you borrowing and what are you investing), what are the matching asset and liability in this hedge, and draw a table showing the inflows and outflows at t=0 and t=6.

Interests Rate Swap [25 points]

a) Life of Pies Baking Goods faces a borrowing cost of 10.25% at the fixed rate and (LIBOR + 0.5%) at the floating rate. 30 Rock Construction Company faces a borrowing cost of 12.75% at the fixed rate and (LIBOR + 1.5%) at the floating rate.

b) Without calculating the QSD, describe which way would an interest rate swap between the above two companies work – i.e., would the swap work if Life of Pies wanted to raise money at the fixed rate or would the swap work if it wanted to raise money at the floating rate? You should simply describe your answer in words, without having to calculate anything. [5 points]

Suppose the two companies set up the swap through an intermediary bank, and say, the QSD is divided equally between these three parties. Now, set up the interest rate swap. You must show the diagram with arrows indicating the relevant interest payments; this diagram should clearly indicate the market where the companies are originally raising capital. Following the diagram, write the equations that describe the set of all feasible interest rate swaps between these parties.You must simplify the equations of the feasible set to get full points.[15 points]

C) Given the feasible set of all interest rate swaps, pick one specific swap that would work. [5 points]

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