Question

Question 3

Consider a five-year currency and interest rate swap, whereby A receives annual payments on Australian dollars and based on a floating interest rate, and B receives annual payments on New Zealand dollars based on a fixed interest rate. The notional involved is AUD100000, the fixed rate is 6 per cent, and he contracted exchange rate is 1.18 (NZD/AUD). If on each payment date, the floating interest rate assumes the values 8.25, 9.75, 5.50, 4.75 and 6 per cent, respectively, and the market exchange rate assumes the values 1.25, 1.15, 1.10, 1.30 and 1.18, then determine the payments made by A to B, and vice versa, and hence the net payments, all in AUD, for the first 3 years (3-periods) of the swap contract.

Answer 1

Current exchange rate = 1.18 NZD / AUD

Amount Exchanged at beginning in New Zealand Dollars = 100000 * 1.18 = 118,000 NZD

here as the base currency of the exchange rate is same as the amount to be converted hence the rate is multiplied by the amount.

Period 1

Amount to be paid by A = 6% * 1118000 = 7080 AUD

Amount to be paid by B = 8.25 % *100000 = 8250 NZD

Net payment will be recieved by A as the floating interest is more than the fixed interest of 6% and the amount by A has to be recieved in AUD hence no conversion required

Amount to be recieved by A = 2.25% * AUD100000 = 2,250 AUD

Amount to be recieved by A = 2250 * 1.25 = 2812.50 NZD

Period 2

Net payment will be recieved by A as the floating interest of 9.75% is more than the fixed interest of 6% and the amount by A has to be recieved in AUD hence no conversion required

Amount to be recieved by A = 3.75% * AUD100000 = 3,750 AUD

Amount to be recieved by A = 3750 * 1.15 = 4312.50 NZD

Period 3

Net payment will be recieved by B as the floating interest of 5.50% is less than the fixed interest of 6% and the B will recieve the payment in NZD hence tha amount has to be converted in NZD

Amount to be recieved by B = 0.5% * AUD100000 * 1.10 = 550 NZD