5. Ashton Bishop is the debt manager for World Telephone, which needs â¬3.33 billion Euro financing for its operations. Bishop is considering the choice between issuance of debt denominated in: ï· Euros (â¬), or ï· U.S. dollars, accompanied by a combined interest rate and currency swap. a. Explain one risk World would assume by entering into the combined interest rate and currency swap. Bishop believes that issuing the U.S.-dollar debt and entering into the swap can lower Worldâs cost of debt by 45 basis points. Immediately after selling the debt issue, World would swap the U.S. dollar payments for Euro payments throughout the maturity of the debt. She assumes a constant currency exchange rate throughout the tenor of the swap. Exhibit 1 gives details for the two alternative debt issues. Exhibit 2 provides current information about spot currency exchange rates and the 3-year tenor Euro/U.S. Dollar currency and interest rate swap. b. Show the notional principal and interest payment cash flows of the combined interest rate and currency swap. Note: Your response should show both the correct currency ($ or â¬) and amount for each cash flow. Answer problem b in the template provided. c. State whether or not World would reduce its borrowing cost by issuing the debt denominated in U.S. dollars, accompanied by the combined interest rate and currency swap. Justify your response with one reason. Exhibit 1 World Telephone Debt Details Chracteristics Euro Currency Debt US Dollar Currency Debt par value EUR 3.33billion $3billion term to maturity 3 years 3 years fixed interest rate 6.25% 7.75% interest payment annual annual Exhibit 2 Currency Exchange rate and swap information Spot currency exchange rate $0.90 per Euro ($0.90/EUR 1.00) 3-year tenor Euro/US Dollar fixed interest rates 5.80% Euro /7.30% US Dollar

OneClass: 5. Ashton Bishop is the debt manager for World Telephone, which needs â¬3.33 billion Euro ...

13. In the currency markets, $1 = 0.75 British pound and 1 Euro = $1.25. Wolverine Cola produces cherry cola in England at a cost of 0.9 British pound per unit. The product is sold in France for 1.5 euros. In terms of U.S. dollars, how much profit is Wolverine realizing on each unit sold?

a. $0.37 b. $0.675 c. $0.875 d. $1.04

14. Which of the following statements is FALSE?

a. Any bond sold outside the country of the borrower is called an international bond.

b. Foreign bonds and Eurobonds are two important types of international bonds.

c. Foreign bonds are bonds sold by a domestic borrower but denominated in a different currency than the country in which the issue is sold.

d. The term Eurobond applies to any bonds that are denominated in a currency that differs from the country in which the issue is sold.

15. The US has a _________________ because we buy more foreign goods than foreigners buy of our goods.

Capital Account Surplus
Current Account Deficit
Current Account Surplus
Capital Account Deficit

16. The current spot price of the S&P is $1200. If the risk free rate is 5% and if owning the S&P would result in $20 of dividend income, then what should the futures price be?

a) $1200 b) $1225 c) $1240 d) $1280

17. ____________ involve two companies exchanging fixed-rate debt for floating-rate debt.

Convertible Debt
Currency Swap
Stock Swap
Interest Rate Swap

18. Which of the following statements about Futures contracts is FALSE?

a) Traded on an organized exchange

b) Profits and losses are marked to market

c) Actual delivery almost always occurs

d) All of the above are true

19. There are call options on the common stock of XYZ Corporation. Which of the following best describes the factors that affect call option values?

a. The price of the call options will rise if XYZ

goldantelope337

Please read the article and answer these questions. Thanks.

Article:

TESTING THE GLOBAL CENTRAL BANK SWAP NETWORK

In the last few weeks, the ECB has been drawing on its liquidity swap line with the Fed, first $308 million for a week, then $658 million for a week, and last week back down to $358 million. Whatâs that about?

Itâs not such a large amount. Bank of Japan borrowed more in the past, $810 million in March and $1528 million in January. But the question then repeats, what was that about?

Both of these drawings are part of the new set of central bank swap lines linking what I call the C6: the Fed, ECB, Bank of Japan, Bank of England, Swiss National Bank, and Bank of Canada. On October 31, 2013these lines were made permanent and unlimited; contract details may be found here. Ever since then I have had a slide in my powerpoints saying âForget the G7, Watch the C6.â

So now weâre watching. What are we seeing?

Central bank swaps are in some ways quite similar to a standard commercial FX swap, but the differences are important and significant.

A standard swap involves exchange of two currencies today at the spot exchange rate prevailing today, plus a promise to reverse the transaction at maturity using the forward exchange rate prevailing today. Suppose that forward rate is calculated using covered interest parity as

F = S(1+r)/(1+r*)

where r and r* are respectively the dollar and foreign interest rate for a given term T, s is the spot exchange rate and f is the forward exchange rate for date T.

In this case, the exposure of the standard swap contract is identical to a swap of IOUs between the contracting parties at the prevailing interest rates in their respective currencies. One party borrows dollars at rate r and the other party borrows euros at the rate r*.

Central bank swaps are different. First, the forward rate in the contract is usually exactly the same as the current spot exchange rate. This means that central banks are never in the position of realizing profits or losses from the swap (although of course there will be implicit profits and losses), that come from deviation between the agreed forward rate and the spot rate at expiry.

Second, the interest rate on the contract is negotiated rather than calculated from market prices. But, given the choice of forward rate, the analogous commercial contract would call for payment of the interest differential, so anything different from that is significant. Significantly, the documentation of the current C6 swap line leaves open the question of who pays interest to who, and how much.

Usual practice has been for the party who draws on the line to pay interest on the line at some penalty rate. Thus the May 9, 2010 swap agreement between the Fed and ECB called for the ECB to pay the USD Overnight Index Swap Rate plus 100 basis points on its dollar borrowing, and the Fed to pay nothing on its euro borrowing. In effect, the ECB was simply borrowing dollars at the discount window, like any other bank, but with its own monetary liability serving as collateral instead of some financial asset.

This kind of arrangement is still in effect a swap of IOUs but at a price that is away from the market. Central bank swap lines thus in effect operate as a kind of outside spread providing bounds within which normal commercial dealing takes place. So long as prices stay at or near CIP, private agents prefer to do business directly with each other. But when CIP comes under pressure, because of one-sided liquidity flows, the central bank moves from backstop to market-maker and the outside price becomes the market price.

The ECB is borrowing dollars from the Fed and lending them on to banks in Europe who have dollar liquidity needs. Here is the tender documentation. Presumably it is doing this for banks who are unable, for whatever reason, to access dollar funding in the open market, or only at a premium that is higher than the ECB charges.

During the financial crisis, dollar funding needs like this got met by central bank liquidity swaps that rose almost to $600 billion, raising questions in Congress. Now, in normal times, smaller sums are becoming a routine way of handling the normal stresses and strains of world funding flows.

For lack of a world central bank, we have a network of central bank liquidity swaps.

(Council on Foreign Relations has a fun interactive app that shows the rest of the emerging swap network as well.)

Questions:

2. Forward rates in standard swaps are set relative to spot rates to eliminate arbitrage opportunities. Using a numerical example, demonstrate that an arbitrage opportunity would exist if a forward exchange rate quote differed from the formula given in Mehrlingâs article.

3. How do swap lines between central banks differ from standard foreign exchange swap contracts? How are forward rates set? How are interest rates determined?

4. Why would a commercial bank borrow foreign currency from its own central bank, rather than using a foreign exchange swap for the purpose?