Question

A UK company is opening a store in the US and needs 390$ investment. Currently exchange rate in the UK is 8.5% and Exchange Rate is 1.6 $/£. Company wants to avoid exchange rate exposure by raising loan from the US. In order to get a favorable term from the US banks, UK company enters a swap with a US firm which also needs financing in UK. According to terms, US company raised 390$ financing from a US bank at a fixed interest rate of 3.5% and is payable in 3 years. Interest Payments are semi-annual.

Zero Rates in the UK and the USA are provided in the below table:

Payment	Zero Rate UK	Zero Rate US
1	0.95	0.94
2	0.94	0.91
3	0.92	0.9
4	0.9	0.88
5	0.89	0.85
6	0.88	0.82

In the below, prepare payment schedule for the UK firm and calculate the present values using Zero Rates.
Payment	UK Pays	Zero Rate	Present Value
1	Answer	Answer	Answer
2	Answer	Answer	Answer
3	Answer	Answer	Answer
4	Answer	Answer	Answer
5	Answer	Answer	Answer
6	Answer	Answer	Answer
Total			Answer
In the below, prepare payment schedule for the US firm and calculate the present values using Zero Rates.
Payment	US Pays	Zero Rate	Present Value
1	Answer	Answer	Answer
2	Answer	Answer	Answer
3	Answer	Answer	Answer
4	Answer	Answer	Answer
5	Answer	Answer	Answer
6	Answer	Answer	Answer
Total			Answer
Value of Swap
	Dollar Value of UK payments	Answer
	Dollar Value of US payments	Answer
	Net Value of Swap (UK payments - US payments)	Answer
	Who must pay to whom?	AnswerUK Firm Pays to US FirmUS Firm Pays to UK Firm

Answer 1

Answer:

Details Given in question:

Loan $390

term 3years

payment half yearly

Principal payment is $65 in each 6 month

Interest rate 3 % per annum

So interest calculation as below

First installment $6.825

Second Installment $5.6875

Third installment $4.55

Fourth installment $3.4125

fifth installment $2.275

Sixth installment $1.1375

So here below table show the payment schedule for uk firm

S.No	UK PAY	Zero rate (given in question)	Present value
1	44.89	.95	48.65 GBP
2	44.18	.94	41.80
3	43.47	.92	39.99
4	42.76	.9	38.48
5	42.05	.89	37.42
6	41.34	.88	36.38
	TOTAL		236.72

UK Pay calculation

Intt+principal /exchange rate

1. ( 6.825+65)/1.6 = 44.89

2. (5.6875+65)/1.6 = 44.18   

3. (4.55+65)/1.6 =43.47

4. (3.4125+65)/1.6 = 42.76

5. (2.275+65)/1.6 = 42.05

6 (1.1375+65)/1.6 = 41.34

Below table show the payment sechdule for US firm

S.NO	UK PAY	ZERO PAY	PRESENT VALUE
1	71.825	.94	$67.52
2	70.69	.91	64.33
3	69.55	.9	62.595
4	68.41	.88	60.20
5	67.275	.85	57.18
6	66.14	.82	54.23
	TOTAL		366.055

USPay calculation

Intt+principal /exchange rate

1. ( 6.825+65) = 71.825

2. (5.6875+65) = 70.69

3. (4.55+65) =69.55

4. (3.4125+65) = 68.41

5. (2.275+65) = 67.275

6 (1.1375+65) = 66.14

Dollar value of UK = 236.72*1.5=378.752

Dollar value of US= 366.055

Net value of SWAP= 378.52-366.055=12.697

So UK FIRM WILL PAY TO US FIRM