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solution

Consider the following currency swap of coupon interest on the following assets:

5 percent (annual coupon) fixed-rate U.S. $1 million bond

5 percent (annual coupon) fixed-rate bond denominated in Swiss francs (SF)
Spot exchange rate: SF1.5/$.

a. What is the face value of the SF bond if the investments are equivalent at spot rates?

b. What are the realized cash flows, assuming no change in spot exchange rates? What are the net cash flows on the swap?

c. What are the cash flows if the spot exchange rate falls to SF0.50/$? What are the net cash flows on the swap?

d. What are the cash flows if the spot exchange rate rises to SF2.25/$? What are the net cash flows on the swap?

e. Describe the underlying cash position that would prompt the FI to hedge by swapping dollars for Swiss francs.

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