There are two ways you can do this valuation: Method 1 is to find the present value of the respective cash flows in the two currencies separately. Then, you convert the PV of the cash flows in the 'other' currency to the currency in which value is being calculated by using the current exchange rate. This is because the PV of cash flows is as of today. Method 2 is to find the net cash flow on each settlement date using the forward exchange rate as of that date and then discount all netted cash flows to today. Both methods give the same final answer.
Very well explained , just a quick doubt , as per my understanding the value of the swap is not 0 at time t=0 as per the Fx rate between USD and AUD, doesn't this type of swap give rise to an arbitrage opportunities, Just a doubt 😊
Hello Sarthak, such a swap with a non-zero value at initiation is called an "off-market swap". In this situation (to ensure fairness), one party pays to the other party a lump-sum amount at the inception of the swap.
I'm a little confused with the notation. You say 0.64 USD/AUD, here AUD is the quoted currency, so it should mean 1 USD = 0.64 AUD. Even if I google USD/AUD rates it will show how much 1 USD is worth. But here you've assumed it means 1 AUD = 0.64 USD. But if we go by the exact lines of the question, it should be written as 0.64 AUD/USD.
In the solution, pls interpret the "/" separating the currencies algebraically i.e. "per unit of". The CFA curriculum follows the price / base convention.
Very helpfull and esay to understand. Well done!
May I know for calculating the fair value of swap, why we use 0.64current exchange rate, but not the projected forward rate?
There are two ways you can do this valuation:
Method 1 is to find the present value of the respective cash flows in the two currencies separately. Then, you convert the PV of the cash flows in the 'other' currency to the currency in which value is being calculated by using the current exchange rate. This is because the PV of cash flows is as of today.
Method 2 is to find the net cash flow on each settlement date using the forward exchange rate as of that date and then discount all netted cash flows to today.
Both methods give the same final answer.
Very well explained
Thank you for the appreciation, J I.
excellent video
Very well explained , just a quick doubt , as per my understanding the value of the swap is not 0 at time t=0 as per the Fx rate between USD and AUD, doesn't this type of swap give rise to an arbitrage opportunities, Just a doubt 😊
Hello Sarthak, such a swap with a non-zero value at initiation is called an "off-market swap". In this situation (to ensure fairness), one party pays to the other party a lump-sum amount at the inception of the swap.
I'm a little confused with the notation. You say 0.64 USD/AUD, here AUD is the quoted currency, so it should mean 1 USD = 0.64 AUD. Even if I google USD/AUD rates it will show how much 1 USD is worth. But here you've assumed it means 1 AUD = 0.64 USD. But if we go by the exact lines of the question, it should be written as 0.64 AUD/USD.
In the solution, pls interpret the "/" separating the currencies algebraically i.e. "per unit of". The CFA curriculum follows the price / base convention.
CFA curriculum is tricky