Currency Swap Concepts and Example (CFA Video)
Currency Swap Concepts and Example (CFA Video)
Question:
A Canadian company enters into a currency swap with a US company for a period of 4 years. At the beginning they exchange 1M USD for 1.1M CAD. The Canadian company will pay fixed rate and US company will pay the variable rate at the beginning of each period. What will happen at the end of the 2nd year, given that:
|
Initial Fixed Rate t=0 |
3% |
|
Fixed Rate at the beginning of the 2nd year (t=1) |
4% |
|
Variable Rate at t=0 |
2% |
|
Variable Rate at t=1 |
4% |
|
Variable Rate at t=2 |
3% |
Answer:
|
|
|
This question is testing if you know how currency swap works and also what interest rate to use in the calculation.
The process of a currency swap is the following:
- At beginning, exchange principals
• Canadian company gives 1.1M CAD and receives 1M USD and vice versa
- At the end of each period, exchange interest for the borrowed currency
• Canadian company pays US company the interest for 1M USD and vice versa
- At the end of the swap, return principals
• Canadian company gives US company back the 1M USD and vice versa
One must note that for the fixed-rate payer, it will use the fixed rate at the beginning of the swap to calculate the interest to pay at the end of each period. Therefore, for the Canadian company, it will use 3% as the interest rate however it changes subsequently. So the Canadian company will pay 0.03 * 1M USD = 30k USD at the end of the 2nd year.
For the variable rate payer, they will use the variable rate at the beginning of each period. So, they will use 4% to calculate the interest to pay at the end of the 2nd year. So the US company has to pay 0.04 * 1.1 CAD = 44k CAD.
THANX A LOT. THIS VID IS VERY MUCH BENEFICIAL FOR ME… IM FROM INDIA. LEVEL 3 – GROUP F – CFA
Nice to meet you Harshit! Good luck to your Level 3!
How can the fixed rate change to 4%. It’s fixed so it does not change right? I know you calculated with 3% i.e at the begening of the swap for year 2, but my question is why is the fixed rate at t=1 @4% even mentioned in the problem? Is it to trick us ? Do we have to know that for swaps the fixed rate does not change ever !
Fixed rate is fixed once you enter the contract. Just like a CD (which is a fixed rate contract), it can be 3% today and 4% tomorrow. If you enter the contract today, it is 3%. If you enter tomorrow, it is 4%. That’s what it means by 4% at t=1. So yes, in this question, fixed rate at t=1 is useless and is to confuse you.
Anybody can understand swap concept by this video.Thanks.
Please provide cross currency and forward point calculation through video.
The lecture was good and knowledgeable . I am grate ful to you.
the video was quite interesting. It made me understood the concept of currency swap.
Great. Thanks a ton. Concept is explained in such a simple and effective manner. I would like to know more about minute-class.com.
i could not understand why US paying variable interest rate and Canada pays fixed interest rate and also why they are only making payment for two year and why they took 4@ variable at the end of two years , what would be the interest rate for US at the end of 3rd and 4 th year.. can u plz suggest me the site to understand this concept.Thanks