Discuss pros and cons of financing in unhedged eurodollars

Assignment Help Financial Management

Reference no: EM13499261

1) You have been provided with the following information on a fixed-fixed USD-GBP currency swap, the spot exchange rate between USD and GBP, and the yield curves for USD and GBP:

- Two-year fixed-fixed currency swap of USD 2.5% for GBP 4.25% based on a notional principal of USD 5,000,000
- Spot exchange rate of GBP 1 = USD 1.5035
- The yield curves for discounting (valuing) cash flows are flat (i.e., the same rate for all relevant maturities) at 1.35% for USD and 3.75% for GBP.

a) What is the implied exchange rate between USD and GBP for the interest payments made under the swap? Should you expect this rate to match the current value of the exchange rate? Explain.

b) Value both sides of the swap. What is the time zero value of the swap to the USD receiver? Does the USD receiver need a settlement payment at the start of the swap to ensure fair value for both parties? Explain.

2) You have the following information:

- Spot exchange rate S(HKD/EUR) 10.6950-10.7050

- One-year forward rate S(HKD/EUR) 10.9150-10.9250

- Hong Kong one-year interest rates 5.275-5.775

- Euro one-year interest rates 2.255-2.375.

a) Calculate the covered margins.

b) Is there a violation of CIP?

c) What would arbitrageurs do given the above information (i.e., explain the process that would be followed by arbitrageurs and its results)?

3) You have the following information:

- The spot rate (time 0 exchange rate) is GBP 1 = AUD 1.4925
- One-year interest rates on AUD and GBP are, respectively, 5.85% and 3.15%
- Assume that the spot rate in one year (the time 1 exchange rate) will be GBP 1 = AUD 1.5035

- The actual one-year forward rate is currently quoted as GBP 1 = AUD 1.5240

a) Calculate the synthetic forward rate from the AUD perspective.

b) Assume GBP 100,000 for the value of the contract. Calculate the value of the settlement payment and who will receive this settlement payment under the forward contract at time 1.

c) If you will be short AUD at time 1, would you choose the synthetic or actual forward rate at time 0? Explain why.

d) Calculate the AUD arbitrage profits available per GBP 100,000 sold in time 1.

4) You have the following information about: rates in London for Eurocurrency loans of one-year duration, the exchange rate between the USD and euros (the latter being the currency in which you want financing), and the level of financing required:

- Eurodollar rates-2.15%
- Euro euro rates-3.75%
- Exchange rate USD 1 = EUR 0.7035 (i.e. EUR/USD 0.7035)
- The volatility (standard deviation) of the above exchange rate is 15.45% p.a.
- You require a total of Euro 250,000,000 to fund capital investments, which is to be repaid at maturity of the loan.

a) Discuss the pros and cons of financing in unhedged Eurodollars instead of via Euro euros. As you do this you must give consideration to the foreign exchange risks associated with financing in Eurodollars.

b) Provide a simple numerical example demonstrating the potential risk from financing in Eurodollars based on the above information.

Reference no: EM13499261

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