Example 1 Assume: 5 year fixed-for fixed currency swap Want to get and pay $ No cash flows at t=0 Notional

ional principal is $1,000,000 5 year YTM is 5.5% for $ and 9% for Spot rate is 1.50 $/ Swap Cash Flows: Pay 0.055(1,000,000) = $55,000 in t=1...5 plus $1,000,000 at t=5 Get 0.090(1,000,000)/1.50 = 60,000 in t=1...5 plus 666,667 at t=5

Example 3 Assume: 6 year fixed-for fixed currency swap Pay 5% dollars Get 7% yen This party is long yen and short dollars in the swap. Spot rate is 140/$ Future spot rates at t=1...6 are 160/$ Find the difference check settlements: $1,000,000 X (1.40) = 140,000,000 . Notional principal is $1 million and 140 million Interest payments are $50,000 and 9.8 million. Contract exchange rate: 9,800,000/50,000 = 196/$ At t=1...6 you pay $50,000 and get 9.8 million worth 9.8 million/1.60= $61,250. Gain $11,250 at t=1...6 from the interest payments. At t=6 you pay $1,000,000 and receive 140 million. 140 million/160 = $875,000. You lose $125,000 at t=6 from principal payment. Summary: You are long yen (you receive yen from the swap). (1) You get 6 payments of $11,250 at t=1...6 (2) You make one payment of $125,000 at t=6

Example 4 Assume: You enter into a 6 year fixed-for fixed currency swap. Receive . Pay $. Current spot rate is 140/$. Notional principal $1,000,000 or 140 million. Swap is at-market (present value of yen and dollar cash flows, adjusted for the spot rates are the same). 6 year coupon rates for both $ and is 7%. Find the swap's cash flows: (1) You are short dollars, so you pay $70,000 at t=1...6 plus $1 million at t=6. (2) You are long yen, so you get 140 mill (.07) = 9.8 million at t=1...6 plus 140 million at t=6.

Example 6 Assume: You enter into a 6 year fixed-for fixed currency swap. Receive at 7% Pay $ at 7%. Spot rate at t=0 is 140/$ which is also the contract exchange rate. Remember that the contract exchange rate is the ratio of the interest payments. Notional principal $1,000,000 or 140 million. Spot rate at t=1 is 120/$. Find the difference check. Notional principal: $1million or 140 million. Interest payments: ($1 mill x .07) = $70,000 and (140 mill x .07) = 9.8 million. The 9.8 million cash flows are worth (9.8 million/ 120/$) = $81,667 at the new exchange rate. At t=1 you pay $ worth $70,000 and receive worth $81,667. You have a gain of $11,667. You are long yen (receive in the swap) and get a difference check of $11,667.

Example 7 Assume Example from 7: You enter into a 6 year fixed-for fixed currency swap. Receive at 7% Pay $ at 7%. Spot rate at t=0 is 140/$ which is also the contract exchange rate. Notional principal $1,000,000 or 140 million. Spot rate at t=6 is 150/$.
Find the settlement of principal at maturity. Notional principal: $1million or 140 million. At maturity you receive 140 million worth $933,333 at a spot rate of 150/$. You receive yen worth $933,333 and pay dollars worth $1 million. Therefore, the principal settlement is: You give the other party (short yen) a check for $66,667.

Example 8 Assume: You enter into a 6 year fixed-for fixed currency swap. Receive 8% . Pay 5% dollars. Current spot rate is 1.60$/. Spot rate at t=2...6 is 1.80$/ Notional principal $1,000,000 or ($1 mill/1.60)=625,000.
Find all the difference checks: You pay $50,000 and get 625,000 x (.08) = 50,000. At t=2...6 you pay $50,000 and get 50,000 worth 50,000 x (1.80) = $90,000. You receive 6 difference checks of $40,000 for interest payments. At t=6 you pay $1 million and receive 625,000 worth 625,000 x 1.80 = $1,125,000. You also receive a principal settlement check at t=6 for $125,000. Notice that the principal payment is based on the exchange rate specified in the swap which is 1.60$/. Even though that isn't the exchange rate at t=6.

Example 5 Assume from Example 5 You enter into a 6 year fixed-for fixed currency swap. Receive . Pay $. Current spot rate is 140/$. Notional principal $1,000,000 or 140 million. 6 year coupon rate and YTM for $ is 7%. 6 year YTM for is 10%. You want to receive a 12% coupon rate on yen. What is the value of the swap? You pay $70,000 t=1...6 plus $1 million at t=6. You want to get 140 million (.12) = 16.8 million at t=1...6 plus 140 million at t=6. 16.8 million (PVIFA10%,6) + 140 million (PVIF10%,6) = 152,194,473 or 152,194,473/140 = $1,087,105 You receive cash flows worth $1,087,105 and pay cash flows worth $1,000,000. Value of the swap is $87,105 or $87,105 x (140) =12,194,700

Example 9 Assume: You enter into a 6 year fixed-for fixed currency swap. Receive 7% . Pay 5% $. Spot rate at t=0 was 140/$ Spot rate at t=3 is 112/$ Notional principal $1,000,000 or 140 million. Swap originated as an at-market swap. At t=3: YTM for 1-ear, 2-ear, and 3-year Euroyen is 7%. YTM for 1-year, 2-ear, and 3-year Eurodollars is 5%. This means that at t=3, the European and Eurodollaryield curves are flat at 7% and 5%. Market-to-market valuation of swaps: The economic amount that must be paid to the long position in a swap to assume that position. The amount may be negative. Find market-to-market (MTM) value after 3 payments. Long pays: $50,000(PVIFA5%, 3) + $1,000,000 (PVIF5%, 3) = $1,000,000 Long receives: 9.8 million (PVIFA7%, 3) + 140 million (PVIF7%, 3) = = 140 million or 140 million/112= $1,250,000 At t=3 the swap has a dollar value of $250,000. Long's position has a marker value of $250,000.

Example 10 Assume: You enter into a 6 year fixed-for fixed currency swap. Receive 7% yen. Pay 5% dollars. Spot rate at t=0 was 140/$ Spot rate at t=3 is 112/$ Notional principal $1,000,000 or 140 million. Swap originated as an at-market swap. Yield Curve Year Yen $ Plus: 1 8% 5% 2 8.5% 5% 3 9% 5% Find MT. value after 3 payments given the new yield curve. Long pays: $50,000 (PVIFA5%,3) + $1,000,000 (PVIF5%,3) = $1,000,000 Long receives: 9.8 mill/(1.08) + 9.8 mill/(1.08.5)2 + 149.8 mill/(1.09)3 = = 133,071,821 or 133,071,821/112 = $1,188,141 At t=3 the swap has a dollar value of $188,141. You would have to pay the long position in the swap $188,141 to assume the position at t=3.

Example 2 Assume: 5 year fixed-for fixed currency swap Want to get and pay $ No cash flows at t=0 Notional principal is $1,000,000 5 year YTM is 5.5% for $ and 9% for Spot rate is 1.50 $/ You want a 5 year 10% coupon bond YTM on 5 year 10% coupon bonds is 9% What is the t=0 payment? This is another way of asking; is this is an at-market swap; and if it is not an at-market swap, what is the swap's value at t=0? Swap Cash Flows: Pay 0.055(1,000,000) = $55,000 at t=1...5 plus $1,000,000 at t=5 Get 0.10(1,000,000)/1.50 = 66,667 at t=1...5 plus 666,667 at t=5 Value of the cash flows discounted at 9% is: 66,667(PVIFA9%,5) + 666,6677(PVIF9%,5) = 692,599 or $1,038,899 This is the price of a 10% coupon bond with a YTM of 9%. Swap's Value: Getting cash flows worth (692,599 x 1.50) = $1,038,899 paying cash flows worth $1,000,000. The swap has a value of $38,899. A cash payment at t=0 of $38,899 or 38,899/1.50 = 25,932 is made by the party receiving pounds to the party receiving dollars.

Example 12 t=0: You enter into a 4 year, off-market, cross-currency swap. YTM: Flat yield curve of 8% for both and $. Notional principal is $1 million or 500,000 at an exchange rate of 2$/. Pay 8% fixed . Get LIBOR + 1.5%, i.e. floating rate $. At t=1 : YTM = still 8% for . 500,000 x .08=40,000. YTM = now $ LIBOR is 5%. $1 million x .065 = $65,000. Spot rate is now 1.75 $/ $ : $65,000(PVIFA5%,3) + $1,000,000(PVIFA5%,3) = $1,040,849 and : 40,000(PVIFA8%,3) + 500,000(PVIFA8%,3) = 500,000 or $875,000 at 1.75$/. Value of the swap at t=1 is $165,8549. In present value terms the floating rate receiver gets $1,040,849 - $875,000 = $165,849 more than it pays. This is the price that the floating rate receiver would charge to assume their position at t=1. What is t=0 payment? LIBOR + 1.5% = 9.5% $ : $95,000 (PVIFA8%4) + $1,000,000 (PVIFA8%,4) = $1,049,682 :40,000(PVIFA8%,4) + 500,000(PVIFA8%,4) = 500,000; $1,000,000 at 2$/. Net: $1,049,682 - $1,000,000 = $49,682 Fixed rate payer pays cash flows worth $1,000,000 and gets $ cash flows worth $1,049,682. So t=0, payment is $49,682.

Example 13 Valuation of fixed-for-fixed currency swaps after origination. 5 year $1,000,000 notional principal. Pay 6% $, Get 9% FF Spot exchange rate is 5 FF/$. FF notional principal is FF5 million. Assume YTM for t=1,2,3 is 6% flat for $ and 9% flat for FF. What is the Swap's value after the 2nd payment.

Swap's value after the 2nd payment (3 interest payments plus a principal payment remaining).

Pay $60,000 at t=1...5 plus $1,000,000 at t=5 Get FF5 million x (9%) = FF450,000 at t=1...5 plus FF5 million at t=5 t=2 end of period two: (1) At 5FF/$ the value of the swap is zero. Present value of $ cash flows equals the present value of FF cash flows: Value of $ paid is: $60,000(PVIFA6%,3)+$1,000,000(PVIF6%,3)=$1,000,000 Value of FF received is: FF450,000(PVIFA9%,3)+FF5 mill(PVIF9%,3)=FF 5 million or FF5 million/5 = $1 million. (2) At 6FF/$ the present value of the FF cash flows (in FF) is still FF5 million. However, in $ the PV of the FF5 million/6 = $833,333. PV of $ cash flows is still $1,000,000. Value of the swap is $1,000,000 - $833,333 = $166,667. To FF receiver, the swap has a negative value of $166,667. You get FF worth $833,333 and pay $1 million. If the FF receiver (the party long FF) wants to liquidate their position, they have to pay the party assuming the long FF position $166,667. (3) At 4FF/$. What is the value of the swap at t=2? Since the yield curve hasn't shifted, the present value of the FF cash flows t=3....5 is still FF5 million. The FF position in $ is FF5million/4 =$1,250,000. You get FF worth $1,250,000 and pay $ worth $1 million. You have a gain of $250,000. So to the FF receiver, the swap has a positive value of $250,000. If the receiver of FF (the party long FF) wants to liquidate their position at t=2, they will require the party assuming the long FF position to pay them $250,000.

Example 11 Assume: U.S.T. pays LIBOR +75bp on 2.5 million. This is a floating rate note (FRN). They could pay 6% fixed in $5 million. Swap Get LIBOR flat on Pay 5% fixed on $. t=0 spot rate is 2$/ and t=1 spot rate is also 2$/ At t=1 LIBOR is 10%. Situation: Given the above information, it is apparent that U.S.T. borrowed at a floating rate of LIBOR + 75bp and wants to swap this into a fixed $ loan at 6%. The swap will save U.S.T. 1% on $5 million or $50,000, but will cost 75bp on 2.5 million loan. This is a cost of (2.5 mill x .0075)=18,750 or $37,500 at 2$/. Net savings to U.S.T. is $50,000 - $37,500 = $12,500.