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Company A is a US company that would like to borrow in Euros to fund an expansion in European Union markets. Company B is a European company that wants to borrow in the US to fund expansion in the US. The following chart shows the rates at which the 2 companies can borrow:
A B
US borrowing ($) 4% 5%
Euro borrowing (€) 3% 2%
If the current exchange rate is $1.10 = 1 €, calculate the following details of a currency swap where A borrows $110,000,000 for 5 years in the US and B borrows 100,000,000 € for 5 years in European markets:
(a) Show the cash flows for both parties if the currency swap requires exchanges every six months.
(b) Calculate the present value of the cash flow going out and coming in from the perspective of A.
(c) Show the implied forward rate of each payment as compared to the actual forward rate (calculated from Barchart)
(d) Describe the risk of A under the swap contract.
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