giorgio10

Why does it look like there is only one payment for the floating?

DSquaredSlim

scratch that

ninja1024

Job..Fantastic explanation. Would you please give one example of currency and equity. Thank you so much. This is very good

bingbingliang

Currency:

You just value each bond in its respective currency then translate into the main currency.

Let's say you want to do a $ for Yen swap with notional principal of $1,0000,000 for 2 years and semiannual payments. Current exchange rate is Y120 to $1. Let's say $ is paying fixed at 6.0% and Y is paying floating, and at initiation, 180 day rate in Japan is 5.5%.

90 days into it, the current interest rate structure is this:
USA
90 day - 4.5%
270 day - 5.5%
450 day - 6.5%
630 day - 7.0%

Japan
90 day - 4.0%
270 day - 5.0%
450 day - 6.0%
630 day - 6.5%

And the current exchange rate is Y110 to $1. What is the value to the receive Yen?

Ok first let's value receive $. This equivalent to buying a fixed rate bond in the USA and issuing a floating rate bond in Japan.

So semiannual payments at 6.0% on $1,000,000 means $30,000 semi annual payments with the $1,000,000 notional principal returning at the final payment. So here is the timeline of when you receive payments:

In 90 days $30,000
In 270 days $30,000
in 450 days $30,000
in 630 days $1,030,000

You discount the above payments in the respective $$$ rates above. So at 90 days, you take 4.5%*90/360 = 1.125% and at 270 days, you take 5.5%*(270/360) = 4.125% and so on.

When you discount the above payments add all that up, you should get $1,003,781

Now the receive Yen bond. First let's figure out the notional principal in Yen. The original exchange rate was Y120 to $1 on $1,000,000 notional principal so that equals Y$120,000,000. The Yen is floating with the first 180 day rate at 5.5% so you value this same way you value floating rate bond in my first example.

The first interest payment = 5.5%*(180/360) = 2.75%*$120,000,000 = Y3,300,000
But you also receive the notional principal back at this point so here is the timeline of cashflows

In 90 days receive Y123,300,000

The 90 day rate is currently 4.0% in Japan. You need to multiply by 90/360 though which equals 1.0%

Value of floating rate Yen bond = 123,300,000/1.01 = 122,079,208

Now convert back at the current exchange rate of Y110 to $1.

Y122,079,208/110 = $1,109,811

Now subtract the two

$1,109,811 - $1,003,781 = $106,030

Sportsman

For the currency swap, the rate used for the 3rd fixed payment should be 6.5%* (450/720) right?

needhelp1700

hmmms I keep getting something else for the fixed rate payment. I'm pretty sure i'm doing it wrong.

For the 3rd and 4th rate for the fixed payments, I did 6.5% * (450/720) and 7.0% * (630/720)

redskins44

N/M i know what I did wrong, it should be 450/360 and 630/360 and not the other way around. I'm retarded..

FinancialAnaly

Thanks job..This is fantastic. Do you have an example of equity?

chandsingh

Great example, however can this be used for Kellyz question asked, I think you said ￡2,114,010 to the receive fixed but how did you work out the coupon on the floating?

If you are not given the 90 day LIBOR at inception of the swap then I am right in thinking you cannot use this method? The correct answer was -￡2,250,000.

WarrenB1

Very good explanation. Helps a great deal. I hate those questions normally.