Question

A company based in the United Kingdom has an Italian subsidiary. The subsidiary generates 25,000,000 a year, received in equivalent semiannual installments of 12,500,000. The British company wishes to convert the euro cash flows to pounds twice a year. It plans to engage in a currency swap in order to lock in the exchange rate at which it can convert the euros to pounds. The current exchange rate is 1.5/E. The fixed rate on a plain vanilla currency swap in pounds is 7.5 percent per year, and the fixed rate on a plain vanilla currency swap in euros is 6.5 percent per year.

a.the notional principals in euros and pounds for a swap with sermi-
b. Determine the semiannual cash flows from this swap.

Answer 1

The UK company can arrange a currency swap with equivalent notional principals based on the exchange rate to ensure consistent semiannual cash flows in pounds, taking into account the fixed percent rates for swaps in both currencies.

Step-by-step explanation:

The scenario described involves a company in the United Kingdom with an Italian subsidiary that generates €25,000,000 yearly, receiving €12,500,000 semiannually. The UK company wishes to engage in a currency swap to convert euros to pounds regularly without being affected by exchange rate fluctuations. With the current exchange rate at 1.5 pounds per euro and given the respective fixed percent rates for swaps in pounds (7.5%) and euros (6.5%), the company can set up a swap with corresponding notional principals and lock in semiannual cash flows in pounds from the euros received.

Without the specific amounts of the notional principals provided and acknowledging that those figures are typically equal in a swap deal, we would assume they start with the equivalent value of €12,500,000 in pounds at the prevailing exchange rate. Then they would enter into an agreement where they receive fixed-rate payments in euros and pay fixed-rate payments in pounds, reflecting the differential in interest rates between the two currencies.