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The annual Central African CFA franc (XAF) interest rate in Gabon is 4% (s.a.), while the annual USD interest rate is 2% (s.a.). Houseman Bank (HB) entered into a currency swap where it receives 3% semiannual in USD and pays 6% semi-annual in XAF. The principals in the two currencies are USD 5 million and XAF 2500 million. Principals are exchanged at maturity. The swap will last for another 12 months (2 payments left). The exchange rate is .002 USD/XAF. For simplicity, assume the term structure in Gabon and in the U.S. is flat. A. Draw the swap cash flows. B. Value this currency swap for HB, using the forward currency contract decomposition.. C. Suppose the Swap dealer is worried about the XAF payments and demands a 1% insurance premium - i.e., XAF interest payments are at 7%. What would be the effect of this insurance premium on the value of the swap for HB? Calculate the value of the swap.
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