Tutorial Problem Set 5

Topic: Chapter 9:
Currency Futures and Swaps
FM303: International Finance
Week 9, Sem. 1, 2019

ANSWER ALL QUESTIONS

Q1. On 1 February, two parties, A and B, sign a forward contract whereby A buys AUD1 million
against the euro at a forward rate (EUR/AUD) of 0.6100 and with a delivery date of 30 June. Who will
tend to default if the spot exchange rate on 30 June assumes the following values: 0.6400; 0.5800; and
0.6100?

Q2. On 13 March, A (as in the previous problem) decides that the AUD1 million amount is no longer
required. To unwind the obligation, A decides to enter a new forward contract whereby a new
counterparty, C, buys AUD1 million at a forward rate of 0.6000 for delivery on 30 June. Explain what
happens on the maturity date by calculating the amounts received and paid by A, B and C.

Q3. On 25 April a trader bought two Australian dollar futures contracts at 0.5500 (USD/AUD).
Calculate the US dollar value of the two contracts. Assuming no daily price limit and no maintenance
margin, calculate the daily variation in the margin account as the settlement rate assumes the following
values:
26 April 0.5600
27 April 0.5730
28 April 0.5430
29 April 0.5580

Q4. On 16 March a US trader bought three Australian dollar futures contracts at 0.5200 (USD/AUD)
when the spot exchange rate was 0.5000. On 14 July, the trader sold the three contracts at 0.5400
and bought the amount spot at 0.5250.
(a) Calculate the value of the three contracts on 16 March.
(b) Calculate the spot value of the Australian dollar amount equal to three contracts on 16 March.
(c) Ignoring marking-to-market, calculate the net gain (loss) from the transactions conducted on 14
July.

Q5. In December 2005 two parties, A and B, agreed on a five-year currency swap whereby A received
payments in Australian dollars and B received payments in Canadian dollars at a contracted exchange
rate of 0.9181 (AUD/CAD). The notional principal of the swap is CAD500 000. The exchange rate
assumed the following values on the payment dates:

Payment date Exchange rate

Dec. 2005 1.0751
Dec. 2006 1.0672
Dec. 2007 1.0555
Dec. 2008 1.1942
Dec. 2009 1.2890

Calculate the payments (in Australian dollar terms) received by A and B on each payment date.

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Q6. In December 2005, two parties, A and B, agreed on a three-year fixed-for-floating Australian
dollar swap, whereby A received payments based on a floating interest rate and B received payments
based on a fixed interest rate. The notional principal is AUD500 000 and the fixed rate is 4.95%. The
floating interest rate assumed the following values on the payment dates:

Payment date Interest rate

Dec. 2006 4.62
Dec. 2007 5.08
Dec. 2008 6.03

Calculate the amounts received by A and B on each payment date.

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RRK/SI/2019/FM303/W8TUT

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 SOLUTION GUIDE
Q1-Solution
(a) At 0.6400 B will receive EUR610 000 for AUD1 000 000 at a time when B could receive EUR640 000
by selling AUD1 000 000 in the spot market. Thus, B will tend to default.
(b) At 0.5800 A will deliver EUR610 000 for AUD1 000 000 at a time when A could deliver EUR580 000
by buying AUD1 000 000 in the spot market. Thus, A will tend to default.
(c) At 0.6100 no one will tend to default as dealing in the spot and the forward markets will give the same
result.

Q2-Solution
On 30 June both forward contracts mature. According to the first contract, A receives AUD1 million from B
in exchange for EUR610 000. According to the second contract, C receives AUD1 million from A in
exchange for EUR600 000. The euro amount is used to make the payment to B while the difference
(EUR10 000) has to be bought by A on the spot market.

Q3-Solution
The US dollar value of the two contracts is:
2  100 000  0.5500  110 000
On the following days the following will happen to the margin account:

Date Settlement rate Value Margin account

26 April 0.5600 112 000 +2000
27 April 0.5730 114 600 +2600
28 April 0.5430 108 600 -6000
29 April 0.5580 111 600 +3000

Q4-Solution
(a) The US dollar value of the three contracts on 16 March is:
3  100 000  0.5200  156 000

(b) The spot US dollar value of the Australian dollar amount is:
3  100 000  0.5000  150 000

(c) Profit obtained by selling the three contracts is:

162 000  156 000  6000
The loss on the spot position is:
157 500  150 000  7500
Hence a net loss of 1500.

Q5-Solution
Because the market rate turns out to be higher than the contract rate on each occasion, B receives net payments
from A as shown in the following table.

Net received by B
Date Exchange rate A receives (AUD) B receives (AUD) (AUD)
Dec. 2005 1.0751 459050 537550 78500
Dec. 2006 1.0672 459050 533600 74550
Dec. 2007 1.0555 459050 527750 68700
Dec. 2008 1.1942 459050 597100 138050
Dec. 2009 1.2890 459050 644500 185450

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Q6-Solution
A receives a net payment from B when the interest rate on the payment date is higher than the fixed
rate of 4.95% and vice versa. Thus, B receives a net amount in 2006, whereas A receives a net
amount in 2007 and 2008. The net amounts received by A and B are as follows:

Date Interest rate A receives B receives

Dec. 2006 4.62 AUD1650
Dec. 2007 5.08 AUD650
Dec. 2008 6.03 AUD5400

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RRK/SI/2019/FM303/W8TUT