For all maturities the US dollar (USD) interest rate is 7% per annum and the Australian dollar (AUD) rate is 9% per annum. The c
urrent value of the AUD is 0.62 USD. In a swap agreement, a financial institution pays 8% per annum in AUD and receives 4% per annum in USD. The principals in the two currencies are $12 million USD and 20 million AUD. Payments are exchanged every year, with one exchange having just taken place. The swap will last two more years. What is the value of the swap to the financial institution
2 answers:
Answer:
Answer is given below.
Explanation:
Given infonnation Current one-year interest rate for USD:7.00.
Current one-year interest rate for AUD: 9.00%
Current spot ex-rate =AUD 0.6200/$
SWAP agreement for financial institution. p.a. in AUD
SWAP agreement for financial institution 096 p.a. in USD
Forward Rate Under Interest Rate Parity (See image)
Arbitrogeof Due to IRP is less than Actual Forward Rate, to get arbitrage exists as follows
Ste l-
Buy 12 Millian US Dollars by taking loan AO. USD Amount Payable after 2 years in Malin USD $ 12.9B
Step-2-
Convert 12 Million US Dollars into AUD at Spot rate and InvesIthese at .8.0096 Arnount of the 12 Million US Dollars into Sterling, at Spot Rate and invest these AUDI,. arnount at AIM Arnount of AUD Received after 2 years AUD22.5.4
Step3 - ConverIthe above AUD at forwar rate Arnount of USD Received after 2 years $ 10.53
Step4, See attachment.
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