Question

8.15 Ganado’s Cross-Currency Swap: Yen for Euros. Use the table of swap rates in the chapter (Exhibit 8.13 ), and assume Ganado enters into a swap agreement to receive euros and pay Japanese yen, on a notional principal of €5,000,000. The spot exchange rate at the time of the swap is ¥104/€.

1. Calculate all principal and interest payments, in both euros and Japanese yen, for the life of the swap agreement.

2. Assume that one year into the swap agreement, Ganado decides it wants to unwind the swap agreement and settle it in euros. Assuming that a 2-year fixed rate of interest on the Japanese yen is now 0.80%, a 2-year fixed rate of interest on the euro is now 3.60%, and the spot rate of exchange is now ¥114/€, what is the net present value of the swap agreement? Who pays whom what?

Answer 1

1). Swap rate for € is 3.24% so Ganado will receive the following cash flows:

Year 1 cash flow (CF1r) = principal amount*3.24% = 5,000,000*3.24% = €162,000

Year 2 cash flow (CF2r) = 5,000,000*3.24% = €162,000

Year 3 cash flow (CF3r) = principal amount + principal amount*3.24% = 5,000,000 + 162,000 = €5,162,000

Current spot rate is Y104/€ so principal amount in Yen = 5,000,000*104 = Y520,000,000

Swap rate for Yen (Y) is 0.59% so Ganado will pay the following cash flows:

Year 1 cash flow (CF1p) = principal amount*0.59% = 520,000,000*0.59% = Y3,068,000

Year 2 cash flow (CF2p) = Y3,068,000

Year 3 cash flow (CF3p) = principal amount + principal amount*0.59% = 520,000,000 + 3,068,000 = Y523,068,000

2). If the swap is to be unwinded at the end of Year 1 then present value (PV) of all remaining cash flows at the end of Year 1 has to be calculated.

Fixed rate for Euro is 3.60% so

PV of cash inflow (CFr) = CF2r/(1+3.60%)^1 + CF3r/(1+3.60%)^2 = 162,000/(1+3.60%)^1 + 5,162,000/(1+3.60%)^2 = €4,965,855

Fixed rate for Yen is 0.80% so

PV of cash outflow (CFp) = 3,068,000/(1+0.80%)^1 + 523,068,000/(1+0.80%)^2 = Y517,841,931

Given spot rate is Y114/€ so PV of CFp in € is 517,841,931/114 = €4,542,473

Net cash settlement at unwinding = CFr - CFp (in €) = 4,965,855 - 4,542,473 = €423,382

Ganado will receive this amount.