Week 6-7: Tutorial Problem Set 6

(Solution Guide ) *

April 14, 2022

Topic: Currency Futures and Swaps

1. 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?
• 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.

• 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.

• At 0.6100 no one will tend to default as dealing in the spot and the
forward markets will give the same result.

2. On 13 March, A (as in the previous problem) decides that the AUD1 mil-
lion 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.

• On 30 June both forward contracts mature. According to the rst

contract, A receives AUD1 million from B in exchange for EUR610 000.

* Prepared by: Course Coordinator Dr. Ronald R. Kumar - Semester 1, 2022-FM303,

School of Accounting, Finance and Economics, The University of the South Pacic, Laucala
Campus, Suva, Fiji

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 Compiled by Dr. Ronald R. Kumar, FM303-Semester 1, 2022, School of Accounting,
Economics and Finance, The University of the South Pacic

According to the second contract, C receives AUD1 million from A in ex-

change for EUR600 000. The euro amount is used to make the payment
to B while the dierence (EUR10 000) has to be bought by A on the spot
market.

3. 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:
Date Settlement rate

26 April 0.5600
27 April 0.5730
28 April 0.5430
29 April 0.5580
Solution:
The value of the 2 contracts is: 2×100 000 (AU D)×0.5500(U SD/AU D) =
110 000U SD

Date Settlement rate (USD/AUD) Value Margin Account

= 0.5600(U SD/AU D) × 200000(AU D) = 112000(U SD) − 110000(U SD)

26 April 0.5600
= 112000(U SD) = +2000(U SD)
= 0.5730(U SD/AU D) × 200 000(AU D) = 114600(U SD) − 112000(U SD)
27 April 0.5730
= 114600(U SD) = +2600(U SD)
= 0.5430(U SD/AU D) × 200000(AU D) = 108600(U SD) − 114600(U SD)
28 April 0.5430
= 108600(U SD) = −2000(U SD)
= 0.5580(U SD/AU D) × 200000(AU D) = 111600(U SD) − 108600(U SD)
29 April 0.5580
= 111600(U SD) = +3000(U SD)

4. 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.
• 1 contract = 100000 AUD so the value of three AUD contracts is:
3 × 100000AU D × 0.5200(U SD/AU D) = 156000U SD.

(b) Calculate the spot value of the Australian dollar amount equal to
three contracts on 16 March.
• spot rate on 16 March is: 0.500(USD/AUD), so the spot value of
three contracts is :
3 × 100000AU D × 0.5000(U SD/AU D) = 150000U SD.
(c) Ignoring marking-to-market, calculate the net gain (loss) from the
transactions conducted on 14 July.
• On July the settlement rate was: 0.5400(USD/AUD) and spot rate
was: 0.5250(USD/AUD). The contract is value on settlement date is:

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 Compiled by Dr. Ronald R. Kumar, FM303-Semester 1, 2022, School of Accounting,
Economics and Finance, The University of the South Pacic

3 × 100000AU D × 0.5400(U SD/AU D) = 162000U SD. The trader

will make a prot by selling the three contracts at this rate. The
prot is: 162000U SD − 156000U SD = 6000U SD.
Considering that if the trader would buy the 300000AUD initially at
spot rate of 0.500U SD/AU D, she would have paid 150000U SD (see
(b)). And if the 300000 AUD was sold at the spot rate of 14 July, the
trader would have received: 300000AU D × 0.5250(U SD/AU D) =
157500U SD. We can see that by trading in the futures contract,
the trader has made a loss on the spot position of 157500U SD −
150000U SD = 7500U SD.
Therefore, the net loss is: +6000U SD − 7500U SD = 1500U SD. Im-
portant point to note is that we are ignoring the marking-to-market
earnings and interest earned on margin account, which if accounted
could have compensated for this loss.

5. In December 2005 two parties, A and B, agreed on a ve 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
Why would we say that the payment ow is one-sided in this case?
Calculate the payments (in Australian dollar terms) received by A and B
on each payment date, and the net ow from one party to the other.
• Because the market rate turns out to be higher than the contract rate
on each occasion, B receives net payments from A.
• Note: 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.
Rule:
• B receives additional payment if CAD appreciates, because the value
of contract is in CAD and B's position is in CAD currency. So if CAD
appreciates, the value of the contract increases, and B is compensated for
this.
• A receives additional payment if CAD depreciates because the value of
contract (in CAD) decreases.
• Note that A's payment is calculated based on the contracted rate of
0.9181(AUD/CAD) and the notional value of the swap contract (CAD5000000).
This means the gross amount received by A will be CAD500000×0.9181(AU D/CAD) =
459050AUD. A's gain is realized when AUD appreciates (CAD depreci-

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Compiled by Dr. Ronald R. Kumar, FM303-Semester 1, 2022, School of Accounting,
Economics and Finance, The University of the South Pacic

ates), and similarly B gains if CAD appreciates.

Market Exchange
rate CAD A receives B receives Net received by B
Payment date
position
AU D

(AU D) (AU D) (AU D)
CAD
= CAD500000× = CAD500000×
appreciate


= 537550 − 459050
Dec. 2005 1.0751 0.9181 AU D 1.0751 AU D
A → B CAD CAD 78500
= 459050 = 537550
= CAD500000× = CAD500000×
appreciate



Dec. 2006 1.0672 0.9181 AU D 1.0672 AU D 74550
A → B CAD CAD
= 459050 = 533600
= CAD500000× = CAD500000×
appreciate



Dec. 2007 1.0555 0.9181 AU D 1.0555 AU D 68700
A → B CAD CAD
= 459050 = 527750
= CAD500000× = CAD500000×
appreciate



Dec. 2008 1.1942 0.9181 AU D 1.0751 AU D 138050
A → B CAD CAD
= 459050 = 597100
= CAD500000× = CAD500000×
appreciate



Dec. 2009 1.2890 0.9181 AU D 1.2890 AU D 185450
A → B CAD CAD
= 459050 = 644500

Just for an example, suppose the rates were as follows:

Payment date Market Exchange rate

Dec. 2005 1.0321

Dec. 2006 0.9971
Dec. 2007 1.0355
Dec. 2008 0.9899
Dec. 2009 0.9982
• A received payments in Australian dollars and
• B received payments in Canadian dollars at a contracted exchange rate
of 0.9181 (AUD/CAD).
Then:

Exchange
Net received
rate CAD A receives B receives
Payment date by B
position
AU D

(AU D) (AU D)
(AU D)
CAD
= CAD500000× = CAD500000×
CAD appreciate



Dec. 2005 1.0321 0.9181 AU D 1.0321 AU D 57000
A → B CAD CAD
= 459050 = 516050
= CAD500000× = CAD500000×
CAD appreciate



Dec. 2006 0.9971 0.9181 AU D 0.9971 AU D 39500
A → B CAD CAD
= 459050 = 498550
= CAD500000× = CAD500000×
CAD appreciate



Dec. 2007 1.0355 0.9181 AU D 1.0355 AU D 58700
A → B CAD CAD
= 459050 = 517750
= CAD500000× = CAD500000×
appreciate



Dec. 2008 0.9899 0.9181 AU D 0.9899 AU D 35900
A → B CAD CAD
= 459050 = 494950
= CAD500000× = CAD500000×
appreciate



Dec. 2009 0.9982 0.9181 AU D 0.9982 AU D 40050
A → B CAD CAD
= 459050 = 499100

The above was not so good example, as the ows are still one directional
because CAD has appreciated all across. Below, I make an attempt with
another example to bring some variations, in the payment ows.

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 Compiled by Dr. Ronald R. Kumar, FM303-Semester 1, 2022, School of Accounting,
Economics and Finance, The University of the South Pacic

Example
Just for an example, suppose now the rates were as follows:
Payment date Market Exchange rate

Dec. 2005 1.0321

Dec. 2006 0.9050
Dec. 2007 1.0355
Dec. 2008 0.9100
Dec. 2009 0.9120
• A received payments in Australian dollars and
• B received payments in Canadian dollars at a contracted exchange rate
of 0.9181 (AUD/CAD).
Then:

Exchange Net Net

Payment date rate
position A receives B receives received received
AU D (AU D) (AU D) by B by A
CAD (AU D) (AU D)
= CAD500000× = CAD500000×
CAD appreciate



Dec. 2005 1.0321 0.9181 AU D 1.0321 AU D 57000
A → B CAD CAD
= 459, 050 = 516, 050
= CAD500000× = CAD500000×
AU D appreciate



Dec. 2006 0.9050 0.9181 AU D 0.9050 AU D 6550
A ← B CAD CAD
= 459, 050 = 452, 500
= CAD500000× = CAD500000×
CAD appreciate



Dec. 2007 1.0355 0.9181 AU D 1.0355 AU D 58700
A → B CAD CAD
= 459, 050 = 517750
= CAD500000× = CAD500000×
AU D appreciate



Dec. 2008 0.9100 0.9181 AU D 0.9100 AU D 4050
A ← B CAD CAD
= 459, 050 = 455, 000
= CAD500000× = CAD500000×
AU D appreciate



Dec. 2009 0.9120 0.9181 AU D 0.9120 AU D 3050
A ← B CAD CAD
= 459, 050 = 456, 000

6. In December 2005, two parties, A and B, agreed on a three-year xed-for-

oating Australian dollar swap, whereby A received payments based on a
oating interest rate and B received payments based on a xed interest
rate. The notional principal is AU D500 000 and the xed rate is 4.95%.
The oating 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.

• A received payments based on a oating interest rate.

• B received payments based on a xed interest rate.
• notional principal is AU D500 000 and the xed rate is 4.95%
• A receives a net payment from B when the interest rate on the payment
date is higher than the xed 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.

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Compiled by Dr. Ronald R. Kumar, FM303-Semester 1, 2022, School of Accounting,
Economics and Finance, The University of the South Pacic

The net amounts received by A and B are as follows:

Payment date Interest rate (%) A Receives (Gross) B Receives (Gross) Net Transfer
A→B
Dec. 2006 4.62 0.0462 × AU D500000
= 23100
0.0495 × AU D500000
= 24750
= 24750 − 23100
AU D1650
Net transfer to B
A←B
Dec. 2007 5.08 0.0508 × AU D500000
= 25400
0.0495 × AU D500000
= 24750
= 25400 − 24750
AU D650
Net transfer to A
A←B
Dec. 2008 6.03 0.0603 × AU D500000
= 30150
0.0495 × AU D500000
= 24750
= 30150 − 24750
AU D5400
Net transfer to A