Problem 8.

1 Amber McClain
Amber McClain, the currency speculator we met earlier in the chapter,sells eight June futures contracts for
500,000 pesos at the closing price quoted in Exhibit 8.1.
a. What is the value of her position at maturity if the ending spot rate is $0.12000/Ps?
b. What is the value of her position at maturity if the ending spot rate is $0.09800/Ps?
c. What is the value of her position at maturity if the ending spot rate is $0.11000/Ps?

Assumptions
Number of pesos per futures contract
Number of contracts
Buy or sell the peso futures?
Ending spot rate ($/peso)
June futures settle price from Exh8.1 ($/peso)
Spot - Futures
Value of total position at maturity (US$)
Value = - Notional x (Spot - Futures) x 8

a.
Values
500,000
8.00
Sell

b.
Values
500,000
8.00
Sell

c.
Values
500,000
8.00
Sell

$0.12000
$0.10773
$0.01227

$0.09800
$0.10773
($0.00973)

$0.11000
$0.10773
$0.00227

($49,080.00)

$38,920.00

($9,080.00)

Interpretation
Amber buys at the spot price and sells at the futures price.
If the futures price is greater than the ending spot price, she makes a profit.

Problem 8.2 Peleh's Puts

Peleh writes a put option on Japanese yen with a strike price of $0.008000/ (125.00/$) at a premium of 0.0080 per yen and with an expiration date six months from now.
The option is for 12,500,000. What is Peleh's profit or loss at maturity if the ending spot rates are 110/$, 115/$, 120/$, 125/$, 130/$, 135/$, and 140/$.

a)
Values
12,500,000
180
$0.008000
$0.000080

b)
Values
12,500,000
180
$0.008000
$0.000080

c)
Values
12,500,000
180
$0.008000
$0.000080

d)
Values
12,500,000
180
$0.008000
$0.000080

e)
Values
12,500,000
180
$0.008000
$0.000080

f)
Values
12,500,000
180
$0.008000
$0.000080

g)
Values
12,500,000
180
$0.008000
$0.000080

110.00
$0.009091

115.00
$0.008696

120.00
$0.008333

125.00
$0.008000

130.00
$0.007692

135.00
$0.007407

140.00
$0.007143

Gross profit on option

Less premium
Net profit (US$/)

$0.000000
($0.000080)
($0.000080)

$0.000000
($0.000080)
($0.000080)

$0.000000
($0.000080)
($0.000080)

$0.000000
($0.000080)
($0.000080)

$0.000308
($0.000080)
$0.000228

$0.000593
($0.000080)
$0.000513

$0.000857
($0.000080)
$0.000777

Net profit, total

($1,000.00)

($1,000.00)

($1,000.00)

($1,000.00)

$2,846.15

$6,407.41

$9,714.29

Assumptions
Notional principal ()
Maturity (days)
Strike price (US$/)
Premium (US$/)
Ending spot rate (/US$)
in US$/

Problem 8.3 Ventosa Investments

Jamie Rodriguez, a currency trader for Chicago-based Ventosa Investments, uses the following futures quotes on the British pound () to speculate on the value of
the pound.
British Pound Futures, US$/pound (CME)
Maturity
March
June
a.
b.
c.
d.

Open
1.4246
1.4164

High
1.4268
1.4188

Low
1.4214
1.4146

Settle
1.4228
1.4162

Change
0.0032
0.0030

If Jaime buys 5 June pound futures, and the spot rate at maturity is $1.3980/, what is the value of her position?
If Jamie sells 12 March pound futures, and the spot rate at maturity is $1.4560/, what is the value of her position?
If Jamie buys 3 March pound futures, and the spot rate at maturity is $1.4560/, what is the value of her position?
If Jamie sells 12 June pound futures, and the spot rate at maturity is $1.3980/, what is the value of her position?
a)
Values
62,500
June
5
buys

b)
Values
62,500
March
12
sells

c)
Values
62,500
March
3
buys

d)
Values
62,500
June
12
sells

$1.3980
$1.4162
($0.0182)

$1.4560
$1.4228
$0.0332

$1.4560
$1.4228
$0.0332

$1.3980
$1.4162
($0.0182)

Value of position at maturity ($)

($5,687.50)
buys: Notional x (Spot - Futures) x contracts
sells: Notional x (Spot - Futures) x contracts

($24,900.00)

$6,225.00

$13,650.00

Assumptions
Pounds () per futures contract
Maturity month
Number of contracts
Did she buy or sell the futures?
Ending spot rate ($/)
Pound futures contract, settle price ($
Spot - Futures

Interpretation
Buys a future: Jamie buys at the futures price and sells at the ending spot price. She therefore profits when the futures price is
less than the ending spot price.
Sells a future: Jamie buys at the ending spot price and sells at the futures price. She therefore profits when the futures price is
greater than the ending spot price.

Contract = 62,500 pounds

Open
High
Interest
1.4700
25,605
1.4550
809

Problem 8.4 Sallie Schnudel

Sallie Schnudel trades currencies for Keystone Funds in Jakarta. She focuses nearly all of her time and attention on the U.S.
dollar/Singapore dollar ($/S$) cross-rate. The current spot rate is $0.6000/S$. After considerable study, she has concluded
that the Singapore dollar will appreciate versus the U.S. dollar in the coming 90 days, probably to about $0.7000/S$. She
has the following options on the Singapore dollar to choose from:
Option
Put on Sing $
Call on Sing $

Strike Price
$0.6500/S$
$0.6500/S$

Premium
$0.00003/S$
$0.00046/S$

a. Should Sallie buy a put on Singapore dollars or a call on Singapore dollars?

b. What is Sallie's breakeven price on the option purchased in part (a)?
c. Using your answer from part (a), what is Sallie's gross profit and net profit (including premium) if the spot rate at the
end of 90 days is indeed $0.7000/S$?
d. Using your answer from part (a), what is Sallie's gross profit and net profit (including premium) if the spot rate at the
end of 90 days is $0.8000/S$?
Option choices on the Singapore dollar:
Strike price (US$/Singapore dollar)
Premium (US$/Singapore dollar)

Call on S$
$0.6500
$0.00046

Assumptions
Current spot rate (US$/Singapore dollar)
Days to maturity
Expected spot rate in 90 days (US$/Singapore dollar)

Put on S$
$0.6500
$0.00003

Values
$0.6000
90
$0.7000

a. Should Sallie buy a put on Singapore dollars or a call on Singapore dollars?

Since Sallie expects the Singapore dollar to appreciate versus the US dollar, she should buy a call on Singapore dollars.
This gives her the right to BUY Singapore dollars at a future date at $0.65 each, and then immediately resell them in the
open market at $0.70 each for a profit. (If her expectation of the future spot rate proves correct.)
b. What is Sallie's breakeven price on the option purchased in part a)?

Note this does not include any interest cost on the premium.

Strike price
Plus premium
Breakeven

Per S$
$0.65000
$0.00046
$0.65046

c. What is Sallie's gross profit and net profit (including premium) if the ending spot rate is $0.70/S$?

Spot rate
Less strike price
Less premium
Profit

Gross profit
(US$/S$)
$0.70000
($0.65000)
$0.05000

Net profit
(US$/S$)
$0.70000
($0.65000)
($0.00046)
$0.04954

d. What is Sallie's gross profit and net profit (including premium) if the ending spot rate is $0.80/S$?

Spot rate
Less strike price
Less premium
Profit

Gross profit
(US$/S$)
$0.80000
($0.65000)
$0.15000

Net profit
(US$/S$)
$0.80000
($0.65000)
($0.00046)
$0.14954

Problem 8.5 Blade Capital (A)

Christoph Hoffeman trades currency for Blade Capital of Geneva. Christoph has $10 million to begin with, and he must state all
profits at the end of any speculation in U.S. dollars. The spot rate on the euro is $1.3358/, while the 30-day forward rate is
$1.3350/.
a. If Christoph believes the euro will continue to rise in value against the U.S. dollar, so that he expects the spot rate to be
$1.3600/ at the end of 30 days, what should he do?
b. If Christoph believes the euro will depreciate in value against the U.S. dollar, so that he expects the spot rate to be $1.2800/
at the end of 30 days, what should he do?

Assumptions
Initial investment (funds available)
Current spot rate (US$/)
30-day forward rate (US$/)
Expected spot rate in 30 days (US$/)

a.
Values
$10,000,000
$1.3358
$1.3350
$1.3600

b.
Values
$10,000,000
$1.3358
$1.3350
$1.2800

Strategy for Part a):

One of the more interesting dimensions of speculating in the forward market is that if the speculator has access to the forward
market (bank lines or relationships when working on behalf of an established firm), many forward speculation strategies require
no actual cash flow position up front. In this case, Christoph believes the dollar will be trading at $1.36/ in the open market at
the end of 30 days, but he has the ability to buy or sell dollars at a forward rate of $1.3350/. He should therefore buy euros
forward 30 days (requires no actual cash flow up front), and at the end of 30 days take delivery of those euros and sell in the spot
market at the higher dollar rate for profit.
Initial investment principle
30 day forward rate (US$/)
Euros bought forward (Investment / forward rate)
Spot rate in open market at end of 30 days (US$/)
US$ proceeds (euros bought forward exchanged to US$ spot)
Profit in US$

$10,000,000.00
$1.3350
7,490,636.70
$1.3600
$10,187,265.92
$187,265.92

Strategy for Part b):

Again, a profitable strategy can be executed without any actual cash flow changing hands at the beginning of the period. Since
Christoph believes that the dollar will strengthen to $1.28 in 30 days, he should sell euros forward now at the higher dollar rate,
wait 30 days and buy the euros needed on the open market at $1.28, and immediately then use those euros to fulfill his forward
contract to sell euros for dollars at $1.3350. For a profit.
Investment funds needed in 30 days
Spot rate in open market at end of 30 days
Euros bought in open market in 30 days (Investment / spot rate)

$10,000,000.00
$1.2800
7,812,500.00

Stefan had sold these euros forward at the start of the 30 day period.
30 day forward rate (US$/)
US$ proceeds (euros sold forward into US$)
Profit in US$

$1.3350
$10,429,687.50
$429,687.50

Problem 8.6 Blade Capital (B)

Christoph Hoffeman of Blade Capital now believes the Swiss franc will appreciate versus the U.S. dollar in the
coming three-month period. He has $100,000 to invest. The current spot rate is $0.5820/SF, the three-month
forward rate is $0.5640/SF, and he expects the spot rates to reach $0.6250/SF in three months.
a. Calculate Christoph's expected profit assuming a pure spot market speculation strategy.
b. Calculate Christoph's expected profit assuming he buys or sells SF three months forward.

Assumptions
Initial investment (funds available)
Current spot rate (US$/Swiss franc)
Six-month forward rate (US$/Swiss franc)
Expected spot rate in six months (US$/Swiss franc)
Strategy for Part a:
1. Use the $100,000 today to buy SF at spot rate
2. Hold the SF indefinitely.
3. At the end of six months, convert SF at expected rate
4. Yielding expected dollar revenues of
5. Realize profit (revenues less $100,000 initial invest)
Strategy for Part b:
1. Buy SF forward six months (no cash outlay required)
2. Fulfill the six months forward in six months
cost in US$
3. Convert the SF into US$ at expected spot rate
4. Realize profit

a.
Values
$100,000
$0.5820
$0.5640
$0.6250

b.
Values
$100,000
$0.5820
$0.5640
$0.6250

SFr. 171,821.31
$0.6250
$107,388.32
$7,388.32

SFr. 177,304.96
($100,000.00)
$110,815.60
$10,815.60

Problem 8.7 Chavez S.A.

Chavez S.A., a Venezuelan company, wishes to borrow $8,000,000 for eight
weeks. A rate of 6.250% per annum is quoted by potential lenders in New York,
Great Britain, and Switzerland using, respectively, international, British, and the
Swiss-Eurobond definitions of interest (day count conventions). From which
source should Chavez borrow?
Assumptions
Principal borrowing need
Maturity needed, in weeks
Rate of interest charged by ALL potential lenders
New York interest rate practices
Interest calculation uses:
Exact number of days in period
Number of days in financial year
So the interest charge on this principal is
Great Britain interest rate practices
Interest calculation uses:
Exact number of days in period
Number of days in financial year
So the interest charge on this principal is
Swiss interest rate practices
Interest calculation uses:
Assumed 30 days per month for two months
Number of days in financial year
So the interest charge on this principal is

Values
8,000,000
8
6.250%

56
360
77,777.78

56
360
77,777.78

60
360
83,333.33

Andina should borrow in Great Britain because it has the lowest interest cost.

Problem 8.8 Botany Bay Corporation

Botany Bay Corporation of Australia seeks to borrow US$30,000,000 in the Eurodollar market. Funding is needed for two years.
Investigation leads to three possibilities. Compare the alternatives and make a recommendation.
#1. Botany Bay could borrow the US$30,000,000 for two years at a fixed 5% rate of interest
#2. Botany Bay could borrow the US$30,000,000 at LIBOR + 1.5%. LIBOR is currently 3.5%, and the rate would be reset every six
months
#3. Botany Bay could borrow the US$30,000,000 for one year only at 4.5%. At the end of the first year Botany Bay would have to
negotiate for a new one-year loan.
Assumptions
Principal borrowing need
Maturity needed, in years
Fixed rate, 2 years
Floating rate, six-month LIBOR + spread
Current six-month LIBOR
Spread
Fixed rate, 1 year, then re-fund

Values
30,000,000
2.00
5.000%
3.500%
1.500%
4.500%
First 6-months

#1: Fixed rate, 2 years

Interest cost per year
Certainty over access to capital
Certainty over cost of capital

Certain
Certain

#2: Floating rate, six-month LIBOR + spread

Interest cost per year
$
Certainty over access to capital
Certainty over cost of capital

750,000
Certain
Certain

#3: Fixed rate, 1 year, then re-fund

Interest cost per year
Certainty over access to capital
Certainty over cost of capital

Certain
Certain

Second 6-months
$

Third 6-months

1,500,000
Certain
Certain

750,000
Certain
Uncertain

1,350,000
Certain
Certain

Fourth 6-months
$

1,500,000
Certain
Certain

750,000
Certain
Uncertain

Certain
Certain

750,000
Certain
Uncertain

???
Uncertain
Uncertain

Only alternative #1 has a certain access and cost of capital for the full 2 year period.
Alternative #2 has certain access to capital for both years, but the interest costs in the final 3 of 4 periods is uncertain.
Alternatvie #3, possessing a lower interest cost in year 1, has no guaranteed access to capital in the second year.
Depending on the company's business needs and tolerance for interest rate risk, it could choose between #1 and #2.

???
Uncertain
Uncertain

Problem 8.9 Vatic Capital

Cachita Haynes works as a currency speculator for Vatic Capital of Los Angeles. Her latest speculative
position is to profit from her expectation that the U.S. dollar will rise significantly against the Japanese yen.
The current spot rate is 120.00/$. She must choose between the following 90-day options on the Japanese
yen:
Option
Put on yen
Call on yen

Strike Price
125/$
125/$

Premium
$0.00003/S$
$0.00046/S$

a. Should Cachita buy a put on yen or a call on yen?

b. What is Cachita's breakeven price on the option purchased in part (a)?
c. Using your answer from part (a), what is Cachita's gross profit and net profit (including premium) if the
spot rate at the end of 90 days is 140/$?
Assumptions
Current spot rate (Japanese yen/US$)
in US$/yen
Maturity of option (days)
Expected ending spot rate in 90 days (yen/$)
in US$/yen

Values
120.00
$0.00833
90
140.00
$0.00714
Call on yen
125.00
$0.00800
$0.00046

Strike price (yen/US$)

in US$/yen
Premium (US$/yen)

Put on yen
125.00
$0.00800
$0.00003

a. Should she buy a call on yen or a put on yen?

Cachita should buy a put on yen to profit from the rise of the dollar (the fall of the yen).
b. What is Cachita's break even price on her option of choice in part a)?
Cachita buys a put on yen. Pays premium today.
In 90 days, exercises the put, receiving US$.
Strike price
Less premium
Breakeven

$0.00800
-$0.00003
$0.00797

in yen/$
125.00
125.47

c. What is Cachita's gross profit and net profit if the end spot rate is 140 yen/$?

Strike price
Less spot rate
Less premium
Profit

Gross profit
(US$/yen)
$0.00800
-$0.00714
$0.00086

Net profit
(US$/yen)
$0.00800
-$0.00714
-$0.00003
$0.00083

Problem 8.10 Calling All Profits

Assume a call option on euros is written with a strike price of $1.2500/ at a premium of 3.80 per euro ($0.0380/) and with an expiration date three months from now. The
option is for 100,000. Calculate your profit or loss should you exercise before maturity at a time when the euro is traded spot at .....
Note: the option premium is 3.8 cents per euro, not 38 cents per euro.

Assumptions
Notional principal (euros)
Maturity (days)
Strike price (US$/euro)
Premium (US$/euro)
Ending spot rate (US$/euro)
Gross profit on option
Less premium
Net profit (US$/euro)
Net profit, total

a.
Values
100,000.00
90
$1.2500
$0.0380
$1.1000

b.
Values
100,000.00
90
$1.2500
$0.0380
$1.1500

c.
Values
100,000.00
90
$1.2500
$0.0380
$1.2000

d.
Values
100,000.00
90
$1.2500
$0.0380
$1.2500

e.
Values
100,000.00
90
$1.2500
$0.0380
$1.3000

f.
Values
100,000.00
90
$1.2500
$0.0380
$1.3500

g.
Values
100,000.00
90
$1.2500
$0.0380
$1.4000

$0.0000
($0.0380)
($0.0380)

$0.0000
($0.0380)
($0.0380)

$0.0000
($0.0380)
($0.0380)

$0.0000
($0.0380)
($0.0380)

$0.0500
($0.0380)
$0.0120

$0.1000
($0.0380)
$0.0620

$0.1500
($0.0380)
$0.1120

($3,800.00)

($3,800.00)

($3,800.00)

($3,800.00)

$1,200.00

$6,200.00

$11,200.00

Problem 8.11 Mystery at Baker Street

Arthur Doyle is a currency trader for Baker Street, a private investment house in London. Baker Streets clients are a collection of
wealthy private investors who, with a minimum stake of 250,000 each, wish to speculate on the movement of currencies. The investors
expect annual returns in excess of 25%. Although officed in London, all accounts and expectations are based in U.S. dollars.
Arthur is convinced that the British pound will slide significantly -- possibly to $1.3200/ -- in the coming 30 to 60 days. The current
spot rate is $1.4260/. Arthur wishes to buy a put on pounds which will yield the 25% return expected by his investors. Which of the
following put options would you recommend he purchase? Prove your choice is the preferable combination of strike price, maturity, and
up-front premium expense.
Strike Price
$1.36/
$1.34/
$1.32/
$1.36/
$1.34/
$1.32/

Maturity
30 days
30 days
30 days
60 days
60 days
60 days

Assumptions
Current spot rate (US$/)
Expected endings spot rate in 30 to 60 days (US$/)
Potential investment principal per person ()

Premium
$0.00081/
$0.00021/
$0.00004/
$0.00333/
$0.00150/
$0.00060/
Values
$1.4260
$1.3200
250,000.00

Put options on pounds

Strike price (US$/)
Maturity (days)
Premium (US$/)

Put #1
$1.36
30
$0.0008

Put #2
$1.34
30
$0.0002

Put #3
$1.32
30
$0.0000

Put options on pounds

Strike price (US$/)
Maturity (days)
Premium (US$/)

Put #4
$1.36
60
$0.0033

Put #5
$1.34
60
$0.0015

Put #6
$1.32
60
$0.0006

Issues for Sydney to consider:

1. Because his expectation is for "30 to 60 days" he should confine his choices to the 60 day options to be sure and capture
the timing of the exchange rate change. (We have no explicit idea of why he believes this specific timing.)
2. The choice of which strike price is an interesting debate.
* The lower the strike price (1.34 or 1.32), the cheaper the option price.
* The reason they are cheaper is that, statistically speaking, they are increasingly less likely to end up in the money.
* The choice, given that all the options are relatively "cheap," is to pick the strike price which will yield the required return.
* The $1.32 strike price is too far 'down,' given that Sydney only expects the pound to fall to about $1.32.

Strike price
Less expected spot rate
Less premium
Profit

Put #4
Net profit
$1.36000
(1.32000)
(0.00333)
$0.03667

Put #5
Net profit
$1.34000
(1.32000)
(0.00150)
$0.01850

Put #6
Net profit
$1.32000
(1.32000)
(0.00060)
($0.00060)

If Sydney invested an individual's principal purely

in this specific option, they would purchase an
option of the following notional principal ():

75,075,075.08

166,666,666.67

416,666,666.67

$2,753,003.00
$356,500.00
772%

$3,083,333.33
$356,500.00
865%

-$250,000.00
$356,500.00
-70%

Expected profit, in total (profit rate x notional):

Initial investment at current spot rate
Return on Investment (ROI)
Risk: They could lose it all (full premium)

Problem 8.12 Contrarious Calandra

Calandra Panagakos works for CIBC Currency Funds in Toronto. Calandra is something of a contrarian -- as opposed to
most of the forecasts, she believes the Canadian dollar (C$) will appreciate versus the U.S. dollar over the coming 90
days. The current spot rate is $0.6750/C$. Calandra may choose between the following options on
the Canadian dollar:
Option
Strike Price
Premium
Put on C$
$0.7000
$0.00003/S$
Call on C$
$0.7000
$0.00049/S$
a. Should Calandra buy a put on Canadian dollars or a call on Canadian dollars?
b. What is Calandra's breakeven price on the option purchased in part (a)?
c. Using your answer from part (a), what is Calandra's gross profit and net profit (including premium) if the spot rate at
the end of 90 days is indeed $0.7600?
d. Using your answer from part (a), what is Calandra's gross profit and net profit (including premium) if the spot rate at
the end of 90 days is $0.8250?
Assumptions
Current spot rate (US$/Canadian dollar)
Days to maturity

Values
$0.6750
90

Option choices on the Canadian dollar:

Strike price (US$/Canadian dollar)
Premium (US$/Canadian dollar)

Call option
$0.7000
$0.00049

Put option
$0.7000
$0.0003

a) Which option should Calandra buy?

Since Giri expects the Canadian dollar to appreciate versus the US dollar, he should buy a call on Canadian dollars.
b) What is Calandra's breakeven price on the option purchased in part a)?
Strike price
Plus premium
Breakeven

$0.7000
0.00049
$0.7005

c) What is Calandra's gross profit and net profit (including premium) if the ending spot rate is $0.7600/C$?

Spot rate
Less strike price
Less premium
Profit

Gross profit
(US$/C$)
$0.7600
(0.7000)
$0.0600

Net profit
(US$/C$)
$0.7600
(0.7000)
(0.00049)
$0.05951

d) What is Calandra's gross profit and net profit (including premium) if the ending spot rate is $0.8250/C$?

Spot rate
Less strike price
Less premium
Profit

Gross profit
(US$/C$)
$0.8250
(0.7000)
$0.1250

Net profit
(US$/C$)
$0.8250
(0.7000)
(0.00049)
$0.12451

Problem 8.13 Raid Gauloises

Raid Gauloises is a rapidly growing French sporting goods and adventure racing outfitter. The company has decided to borrow 20,000,000 via a euroeuro floating rate loan for four years. Raid must decide between two competing loan offerings from two of its banks.
Banque de Paris has offered the four-year debt at euro-LIBOR + 2.00% with an up-front initiation fee of 1.8%. Banque de Sorbonne, however, has
offered euro-LIBOR + 2.5%, a higher spread, but with no loan initiation fees up-front, for the same term and principal. Both banks reset the interest
rate at the end of each year.
Euro-LIBOR is currently 4.00%. Raids economist forecasts that LIBOR will rise by 0.5 percentage points each year. Banque de Sorbonne,
however, officially forecasts euro-LIBOR to begin trending upward at the rate of 0.25 percentage points per year. Raid Gauloisess cost of capital is
11%. Which loan proposal do you recommend for Raid Gauloises?

Assumptions
Principal borrowing need
Maturity needed, in years
Current euro-LIBOR
Banque de Paris' spread & expectation
Banque de Paris' initiation fee
Banque de Sorbonne's spread & expectation
Banque de Sorbonne's initiation fee

Values
20,000,000
4.00
4.000%
2.000%
1.800%
2.500%
0.000%

Expected Chg
in LIBOR

0.500%
0.250%

Raid Gauloises must evaluate both loan proposals under both potential interest rate scenarios.
Banque de Paris Loan Proposal
Expected interest rates & payments:
Expected euro-LIBOR
Bank spread
Interest rate
Funds raised, net of fees
Expected interest costs
Repayment of principal
Total cash flows
All-in-cost of funds if:
euro-LIBOR rises 0.500% per year
euro-LIBOR rises 0.250% per year
Banque de Sorbonne Loan Proposal
Expected interest rates & payments:
Expected euro-LIBOR
Bank spread
Interest rate
Funds raised, net of fees
Expected interest costs
Repayment of principal
Total cash flows
All-in-cost of funds if:
euro-LIBOR rises 0.500% per year
euro-LIBOR rises 0.250% per year

Year 0

Year 1

Year 2

Year 3

Year 4

4.000%
2.000%
6.000%

4.500%
2.000%
6.500%

5.000%
2.000%
7.000%

5.500%
2.000%
7.500%

6.000%
2.000%
8.000%

- 1,300,000

- 1,400,000

- 1,500,000

- 1,300,000

- 1,400,000

- 1,500,000

- 1,600,000
- 20,000,000
- 21,600,000

19,640,000

19,640,000

7.7438%
7.1365%

Found by plugging in .250% in expectations above.

Year 0

Year 1

Year 2

Year 3

Year 4

4.000%
2.500%
6.500%

4.250%
2.500%
6.750%

4.500%
2.500%
7.000%

4.750%
2.500%
7.250%

5.000%
2.500%
7.500%

- 1,350,000

- 1,400,000

- 1,450,000

- 1,350,000

- 1,400,000

- 1,450,000

- 1,500,000
- 20,000,000
- 21,500,000

20,000,000

20,000,000

7.0370%
7.1036%

Found by plugging in .500% in expectations above.

The Banque de Sorbonne loan proposal is actually lower all-in-cost under either interest rate scenario.

Problem 8.14 Schifano Motors

Schifano Motors of Italy recently took out a 4-year 5 million loan on a floating rate basis. It is now worried, however, about rising interest
costs. Although it had initially believed interest rates in the Euro-zone would be trending downward when taking out the loan, recent
economic indicators show growing inflationary pressures. Analysts are predicting that the European Central Bank will slow monetary
growth driving interest rates up.
Schifano is now considering whether to seek some protection against a rise in euro-LIBOR, and is considering a Forward Rate
Agreement (FRA) with an insurance company. According to the agreement, Schifano would pay to the insurance company at the end of
each year the difference between its initial interest cost at LIBOR + 2.50% (6.50%) and any fall in interest cost due to a fall in LIBOR.
Conversely, the insurance company would pay to Schifano 70% of the difference between Schifanos initial interest cost and any increase in
interest costs caused by a rise in LIBOR.
Purchase of the floating Rate Agreement will cost 100,000, paid at the time of the initial loan. What are Schifanos annual financing
costs now if LIBOR rises and if LIBOR falls.? Schifano uses 12% as its weighted average cost of capital. Do you recommend that Schifano
purchase the FRA?
Assumptions
Principal borrowing need
Maturity needed, in years
Current LIBOR
Felini's bank spread
Proportion of differential paid by FRA
Cost of FRA

Values
5,000,000
4.00
4.000%
2.500%
70%
100,000

If LIBOR Falls 50 Basis Pts Per Year

Year 0

Year 2

Year 3

Year 4

3.500%
2.500%
6.000%

3.000%
2.500%
5.500%

2.500%
2.500%
5.000%

2.000%
2.500%
4.500%

- 100,000

- 300,000
- 25,000

- 275,000
- 50,000

- 250,000
- 75,000

4,900,000

- 325,000

- 325,000

- 325,000

- 225,000
- 100,000
- 5,000,000
- 5,325,000

Year 1

Year 2

Year 3

Year 4

4.500%
2.500%
7.000%

5.000%
2.500%
7.500%

5.500%
2.500%
8.000%

6.000%
2.500%
8.500%

- 100,000

- 350,000
17,500

- 375,000
35,000

- 400,000
52,500

4,900,000

- 332,500

- 340,000

- 347,500

- 425,000
70,000
- 5,000,000
- 5,355,000

Expected annual change in LIBOR

LIBOR
Bank spread
Interest rate
Funds raised, net of fees
Expected interest (interest rate x principal)
Forward Rate Agreement
Repayment of principal
Total cash flows
All-in-cost of funds (IRR)

If LIBOR Rises 50 Basis Pts Per Year

-0.500%
4.000%
2.500%
6.500%
5,000,000

7.092%

Year 0

Expected annual change in LIBOR

LIBOR
Bank spread
Interest rate
Funds raised, net of fees
Expected interest (interest rate x principal)
Forward Rate Agreement
Repayment of principal
Total cash flows
All-in-cost of funds (IRR)

Year 1

0.500%
4.000%
2.500%
6.500%
5,000,000

7.458%

This rather unusual forward rate agreement is somewhat one-sided in the favor of the insurance company. When Schifano is correct,
Schifano pays the full difference in rates to the insurance company. But when interest rates move against Schifano, the insurance company
pays Schifano only 70% of the difference in rates. And all of that is after Schifano paid 100,000 up-front for the agreement regardless of
outcome. Not a very good deal.
A final note of significance is that since Schifano receives only 70% of the difference in rates, its total cost of funds is not effectively
"capped"; they could in fact rise with no limit over the period as interest rates rose.

Problem 8.15 Chrysler LLC

Chrysler LLC, the now privately held company sold-off by DaimlerChrysler, must pay floating rate interest
three months from now. It wants to lock in these interest payments by buying an interest rate futures contract.
Interest rate futures for three months from now settled at 93.07, for a yield of 6.93% per annum.
a. If the floating-rate interest three months from now is 6.00%, what did Chrysler gain or lose?
b. If the floating-rate interest three months from now is 8.00% , what did Chrysler gain or lose?

Assumptions
Interest rate futures, closing price
Effective yield on interest rate futures

Chrysler's interest rate payments with futures

Interest payment due in three months
Sell a future (take a short position)
Gain or loss on position

Values
93.07
6.930%
Three Months From Now
Floating Rate is
Floating Rate is
6.000%
8.000%
6.000%
-6.930%
-0.930%
Loss

8.000%
-6.930%
1.070%
Gain

Problem 8.16 CB Solutions

Heather O'Reilly, the treasurer of CB Solutions, believes interest rates are going to rise, so she wants to swap her future floating
rate interest payments for fixed rates. At present she is paying LIBOR + 2% per annum on $5,000,000 of debt for the next two
years, with payments due semiannually. LIBOR is currently 4.00% per annum. Heather has just made an interest payment today,
so the next payment is due six months from today.

Heather finds that she can swap her current floating rate payments for fixed payments of 7.00% per annum. (CB Solutions's
weighted average cost of capital is 12%, which Heather calculates to be 6% per six month period, compounded semiannually).
a. If LIBOR rises at the rate of 50 basis points per six month period, starting tomorrow, how much does Heather save or cost her
company by making this swap?
b. If LIBOR falls at the rate of 25 basis points per six month period, starting tomorrow, how much does Heather save or cost her
company by making this swap?
Assumptions
Notional principal
LIBOR, per annum
Spread paid over LIBOR, per annum
Swap rate, to pay fixed, per annum

Values
5,000,000
4.000%
2.000%
7.000%
First
6-months

Second
6-months

Third
6-months

Fourth
6-months

0.500%
4.500%

5.000%

5.500%

6.000%

Current loan agreement:

Expected LIBOR (for 6 months)
Spread (for 6 months)
Expected interest payment

-2.250%
-1.000%
-3.250%

-2.500%
-1.000%
-3.500%

-2.750%
-1.000%
-3.750%

-3.000%
-1.000%
-4.000%

Swap Agreement:
Pay fixed (for 6-months)
Receive floating (LIBOR for 6 months)

-3.500%
2.250%

-3.500%
2.500%

-3.500%
2.750%

-3.500%
3.000%

Net interest (loan + swap)

-4.500%

-4.500%

-4.500%

-4.500%

Interest & Swap Payments

a. LIBOR increases 50 basis pts/6 months
Expected LIBOR

Swap savings?
Net interest after swap
Loan agreement interest
Swap savings (swap cost)

$
$

(225,000)
(162,500)
(62,500)

$
$

(225,000)
(175,000)
(50,000)

$
$

(225,000)
(187,500)
(37,500)

$
$

(225,000)
(200,000)
(25,000)

b. LIBOR decreases 25 basis pts/6 months

Expected LIBOR

-0.250%
3.750%

3.500%

3.250%

3.000%

Current loan agreement:

Expected LIBOR (for 6 months)
Spread (for 6 months)
Expected interest payment

-1.875%
-1.000%
-2.875%

-1.750%
-1.000%
-2.750%

-1.625%
-1.000%
-2.625%

-1.500%
-1.000%
-2.500%

Swap Agreement:
Pay fixed (for 6-months)
Receive floating (LIBOR for 6 months)

-3.500%
1.875%

-3.500%
1.750%

-3.500%
1.625%

-3.500%
1.500%

Net interest (loan + swap)

-4.500%

-4.500%

-4.500%

-4.500%

Swap savings?
Net interest after swap
Loan agreement interest
Swap savings (swap cost)

$
$

(225,000)
(143,750)
(81,250)

$
$

(225,000)
(137,500)
(87,500)

$
$

In both cases CB Solutions is suffering higher total interest costs as a result of the swap.

(225,000)
(131,250)
(93,750)

$
$

(225,000)
(125,000)
(100,000)

Problem 8.17 Lluvia and Paraguas

Lluvia Manufacturing and Paraguas Products both seek funding at the lowest possible cost. Lluvia would
prefer the flexibility of floating rate borrowing, while Paraguas wants the security of fixed rate
borrowing. Lluvia is the more credit-worthy company. They face the following rate structure. Lluvia,
with the better credit rating, has lower borrowing costs in both types of borrowing.
Lluvia wants floating rate debt, so it could borrow at LIBOR+1%. However it could borrow fixed at
8% and swap for floating rate debt. Paraguas wants fixed rate, so it could borrow fixed at 12%. However
it could borrow floating at LIBOR+2% and swap for fixed rate debt. What should they do?

Assumptions
Credit rating
Prefers to borrow
Fixed-rate cost of borrowing
Floating-rate cost of borrowing:
LIBOR (value is unimportant)
Spread
Total floating-rate
Comparative Advantage in Borrowing
Lluvia's absolute advantage:
in fixed rate borrowing
in floating-rate borrowing
Comparative advantage in fixed rate
One Possibility
Lluvia borrows fixed
Paraguas borrows floating
Lluvia pays Paraguas floating (LIBOR)
Paraguas pays Lluvia fixed
Net interest after swap
Savings (own borrowing versus net swap):
If Lluvia borrowed floating
If Lluvia borrows fixed & swaps with Paraguas

If Paraguas borrows fixed

If Paraguas borrows floating & swaps with Lluvia

Xavier
AAA
Floating
8.000%

Zulu
BBB
Fixed
12.000%

5.000%
1.000%
6.000%

5.000%
2.000%
7.000%

Values
4.000%
1.000%
3.000%
Xavier
-8.000%
---5.000%
8.500%
-4.500%

Zulu
---7.000%
5.000%
-8.500%
-10.500%

6.000%
4.500%
1.500%
12.000%
10.500%
1.500%

The 3.0% comparative advantage enjoyed by Lluvia represents the opportunity set for improvement for
both parties. This could be a 1.5% savings for each (as in the example shown) or any other combination
which distributes the 3.0% between the two parties.

Problem 8.18 Trident's Cross Currency Swap: Sfr for US$

Trident Corporation entered into a three-year cross currency interest rate swap to receive U.S. dollars and pay Swiss francs. Trident, however, decided
to unwind the swap after one year thereby having two years left on the settlement costs of unwinding the swap after one year. Repeat the
calculations for unwinding, but assume that the following rates now apply:
Assumptions
Notional principal
Original spot exchange rate, SFr./$
New (1-year later) spot exchange rate, SFr./$
New fixed US dollar interest
New fixed Swiss franc interest

a. Interest & Swap Payments

Receive fixed rate dollars at this rate:
On a notional principal of:
Trident will receive cash flows:

Values
10,000,000
1.5000
1.5560
5.20%
2.20%
Year 0

Year 1

Year 2

Year 3

5.56%

5.56%

5.56%

###

###

###

SFr. 301,500

SFr. 301,500

SFr. 15,301,500

SFr. 15,000,000

b. Unwinding the swap after one-year

Settlement:
Cash inflow
Cash outflow
Net cash settlement of unwinding

3-year ask
5.59%
2.01%

10,000,000

Trident will pay cash flows:

On a notional principal of:
Pay fixed rate Swiss francs at this rate:

Remaining Swiss franc cash outflows

PV factor at now current fixed SF interest
PV of remaining SF cash outflows
Cumulative PV of SF cash outflows
New current spot rate, SFr./$
Cumulative PF of SF cash outflows in $

3- year bid
5.56%
1.93%

1.5000

Exchange rate, time of swap (SFr./$)

Remaining dollar cash inflows

PV factor at now current fixed $ interest
PV of remaining dollar cash inflows
Cumulative PV of dollar cash inflows

Swap Rates
Original: US dollar
Original: Swiss franc

2.01%

2.01%

2.01%

Year 1

Year 2

Year 3

$
5.20%
$
$

556,000
0.9506
528,517

$
$

10,066,750

2.20%

SFr. 301,500
0.9785
SFr. 295,010

SFr. 14,944,827
1.5560
$
9,604,645

$
$

10,556,000
0.9036
9,538,232

10,066,750
(9,604,645)
462,105

This is a cash receipt by Trident from the swap dealer.

SFr. 15,301,500
0.9574
SFr. 14,649,818

Problem 8.19 Trident's Cross Currency Swap: Yen for Euros

Using the table of swap rates in the chapter (Exhibit 8.13), and assume Trident 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/.
a. Calculate all principal and interest payments, in both euros and Swiss francs, for the life of the swap agreement.
b. Assume that one year into the swap agreement Trident decides it wishes to unwind the swap agreement and settle it in euros. Assuming that a
two-year fixed rate of interest on the Japanese yen is now 0.80%, and a two-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?

Assumptions
Notional principal
Spot exchange rate, Yen/euro

Values
5,000,000
104.00

a) Interest & Swap Payments

Receive fixed rate euros at this rate:
On a notional principal of:
Trident will receive cash flows:

Swap Rates
Euros --
Japanese yen

Year 0

3- year bid
3.24%
0.56%

3-year ask
3.28%
0.59%

Year 1

Year 2

Year 3

3.24%

3.24%

3.24%

5,000,000

###

###

###

523,068,000

Exchange rate, time of swap (/)

104.00

Trident will pay cash flows:

On a notional principal of (yen):
Pay fixed rate Japanese yen at this rate:

b) Unwinding the swap after one-year

Remaining euro cash inflows
PV factor at now current fixed interest
PV of remaining cash inflows
Cumulative PV of cash infllows
Remaining cash outflows
PV factor at now current fixed interest
PV of remaining cash outflows
Cumulative PV of cash outflows
New current spot rate, /
Cumulative PV of cash outflows in
Settlement:
Cash inflow
Cash outflow
Net cash settlement of unwinding

3,068,000

3,068,000

520,000,000

3.60%

0.59%

0.59%

0.59%

Year 1

Year 2

Year 3

162,000
0.9653
156,371

5,162,000
0.9317
4,809,484

SFr. 3,068,000
0.9921
SFr. 3,043,651

SFr. 523,068,000
0.9842
SFr. 514,798,280

4,965,855

0.80%
517,841,931
114.00
4,542,473

4,965,855
(4,542,473)
423,382

This is a cash receipt by Trident from the swap dealer.

Problem 8.20 Falcor

Falcor is the U.S.-based automotive parts supplier which was spun-off from General Motors in 2000. With annual sales of over $26 billion, the company has expanded its markets
far beyond the traditional automobile manufacturers in the pursuit of a more diversified sales base. As part of the general diversification effort, the company wishes to diversify
the currency of denomination of its debt portfolio as well. Assume Falcor enters into a $50 million 7-year cross currency interest rate swap to do just that pay euro and receive
dollars. Using the data in Exhibit 8.13, solve the following:
a. Calculate all principal and interest payments in both currencies for the life of the swap.
b. Assume that three years later Falcor decides to unwind the swap agreement. If 4-year fixed rates of interest in euros have now risen to 5.35% and 4-year fixed rate dollars have
fallen to 4.40%, and the current spot exchange rate of $1.02/, what is the net present value of the swap agreement? Who pays who mwhat?

Assumptions
Notional principal
Spot exchange rate, $/

Values
50,000,000
1.16

a. Interest & Swap Payments

Receive fixed rate dollars at rate:
Notional principal of:
Receive cash inflows of:

Year 0

Swap Rates
US dollar
Euros

Year 1

7- year bid
5.86%
4.01%

7-year ask
5.89%
4.05%

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

5.86%
50,000,000
$ 2,930,000 $ 2,930,000 $ 2,930,000 $ 2,930,000 $ 2,930,000 $ 2,930,000 $ 52,930,000

Spot exchange rate, $/

1.16

Pay cash outflows of:

Notional principal of:
Pay fixed rate euros at rate:

1,745,690

1,745,690

1,745,690

1,745,690

1,745,690

1,745,690

44,849,138

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

43,103,448
4.05%

b. Unwindingthe Swap

Year 0

If the swap is unwound three years later, there are four years of cash flows remaining:
Remaining dollar cash inflows
PV factor at now current fixed $ interest
PV of remaining dollar cash inflows
Cumulative PV of $ cash infllows

Remaining euro cash outflows

PV factor at now current fixed interest
PV of remaining euro cash outflows
Cumulative PV of cash outflows
Spot exchange rate at unwinding ($/)
Cumulative PV of cash outflows, $
Settlement:
Cash inflow
Cash outflow
Net cash settlement of unwinding

4.40%
$

$ 2,930,000 $ 2,930,000 $ 2,930,000 $ 52,930,000

0.9579
0.9175
0.8788
0.8418
$ 2,806,513 $ 2,688,231 $ 2,574,934 $ 44,555,354

52,625,033

5.35%

1,745,690
0.9492
1,657,038

41,132,542
1.02
$ 41,955,193

52,625,033
(41,955,193)
$ 10,669,840

This is a net cash payment to Falcor from the swap dealer.

1,745,690
0.9010
1,572,889

1,745,690
0.8553
1,493,012

44,849,138
0.8118
36,409,603