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Sixty days ago, a European company entered into a receive-fixed GBP, pay-fixed EUR swap with the following specifications:Currently, long positions in the associated bonds with unit face value are priced at EUR 1.06 and GBP 0.97, respectively. If the current exchange rate is 0.91 GBP/EUR, the value of the swap to the European company is closest to: A.GBP 250,500. B.GBP 396,000. C.GBP 693,057. Solution A Correct because the value of a fixed-for-fixed currency swap at some future point in time, say Time t, is simply the difference in a pair of fixed-rate bonds, one expressed in currency a [here GBP] and one expressed in currency b [here EUR]. To express the bonds in the same currency units, we convert the currency b bond into units of currency a through a spot foreign exchange transaction at a new rate St. The value of a ‘receive currency a, pay currency b’ (fixed-for-fixed) swap at any time t expressed in terms of currency a is the difference in bond values: VCS = Va – StVb. Moreover, the NA (or par value) of the bond denominated in currency a (NAa) must equal the spot exchange rate S0 times the notional amount (or par value) of the bond denominated in currency b (NAb). That is, NAa = S0 × NAb = 0.88 × 5,000,000 = GBP 4,400,000. Finally, the value of each fixed-rate bond can be computed by multiplying the notional amount in that currency by the value of a long position in a bond with face value equal to one unit of that currency (the values given in the question). Hence, VCS = (4,400,000 × 1.06) – [0.91 × (5,000,000 × 0.97)] = 4,664,000 – 4,413,500 = GBP 250,500. B Incorrect because it uses the exchange rate at initiation, rather than after 60 days, to convert the EUR fixed-rate bond value to GBP, yielding: VCS = (4,400,000 × 1.06) – [0.88 × (5,000,000 × 0.97)] = 4,664,000 – 4,268,000 = GBP 396,000. C Incorrect because it misinterprets the stated exchange rates as EUR per GBP, rather than GBP per EUR, i.e., concluding that S0 = 1/0.88 = 1.1363636 (GBP/EUR) and St = 1/0.91 = 1.0989011 (GBP/EUR). This yields:

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Sixty days ago, a European company entered into a receive-fixed GBP, pay-fixed EUR swap with the following specifications:Currently, long positions in the associated bonds with unit face value are priced at EUR 1.06 and GBP 0.97, respectively. If the current exchange rate is 0.91 GBP/EUR, the value of the swap to the European company is closest to: A.GBP 250,500. B.GBP 396,000. C.GBP 693,057. Solution A Correct because the value of a fixed-for-fixed currency swap at some future point in time, say Time t, is simply the difference in a pair of fixed-rate bonds, one expressed in currency a [here GBP] and one expressed in currency b [here EUR]. To express the bonds in the same currency units, we convert the currency b bond into units of currency a through a spot foreign exchange transaction at a new rate St. The value of a ‘receive currency a, pay currency b’ (fixed-for-fixed) swap at any time t expressed in terms of currency a is the difference in bond values: VCS = Va – StVb. Moreover, the NA (or par value) of the bond denominated in currency a (NAa) must equal the spot exchange rate S0 times the notional amount (or par value) of the bond denominated in currency b (NAb). That is, NAa = S0 × NAb = 0.88 × 5,000,000 = GBP 4,400,000. Finally, the value of each fixed-rate bond can be computed by multiplying the notional amount in that currency by the value of a long position in a bond with face value equal to one unit of that currency (the values given in the question). Hence, VCS = (4,400,000 × 1.06) – [0.91 × (5,000,000 × 0.97)] = 4,664,000 – 4,413,500 = GBP 250,500. B Incorrect because it uses the exchange rate at initiation, rather than after 60 days, to convert the EUR fixed-rate bond value to GBP, yielding: VCS = (4,400,000 × 1.06) – [0.88 × (5,000,000 × 0.97)] = 4,664,000 – 4,268,000 = GBP 396,000. C Incorrect because it misinterprets the stated exchange rates as EUR per GBP, rather than GBP per EUR, i.e., concluding that S0 = 1/0.88 = 1.1363636 (GBP/EUR) and St = 1/0.91 = 1.0989011 (GBP/EUR). This yields:

It is clearly stated in the question that the European co is receiving fixed GBP, this means that it has lent GBP in exchange for EURO and at maturity of the swap, it will receive back GBP notional and give ...

currency swaps