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Question - A company based in the United Kingdom has an Italian subsidiary. The subsidiary generates €20,000,000 a year, received in equivalent semiannual installments of €10,000,000. The British company wishes to convert the euro cash flows to pounds twice a year. It plans to engage in a currency swap in order to lock in the exchange rate at which it can convert the euros to pounds. The current exchange rate is €1.1574/£. The fixed-rate on a plain vanilla currency swap in pounds is 4.0 percent per year, and the fixed rate on a plain vanilla currency swap in euros is 5.0 percent per year.
Required -
a. Determine the notional principals in euros and pounds for a swap with semiannual payments that will help achieve the objective.
b. Determine the semiannual cash flows from this swap.
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