Find value of the swap to the financial institution

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Company A, a British manufacturer, wishes to borrow U.S. dollars at a fixed rate of interest. Company B, a U.S. multinational, wishes to borrow sterling at a fixed rate of interest. They have been quoted the following rates per annum (adjusted for differential tax effects): 

 

Sterling

US Dollars

Company A

11%

7.00%

Company B

10.4%

6.2%

a. Design a swap that will net a bank, acting as intermediary, 20 basis points per annum.

b. Suppose that the term structure of risk-free interest rates is flat in the United States and Australia. The USD interest rate is 5% per annum and the AUD rate is 10% per annum.  The current value of the AUD is 0.78 USD. Under the terms of a swap agreement, a financial institution pays 8% per annum in AUD and receives 4% per annum in USD.  The principals in the two currencies are $14 million USD and 25 million AUD.  Payments are exchanged every year, with one exchange having just taken place. The swap will last three more years. What is the value of the swap to the financial institution, assuming all interest rates are continuously compounded?

Reference no: EM133056076

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