May 2000 #4

[LB]

For some reason I cannot grasp this!!

1. Swap notional amount
2. Time 1 US company pays in pounds to UK company. Where does the US company gets this money from? Do they invest in UK market with the 12.5 million pounds?

[Exam Slave]

1. In currency swaps, notional amounts are exchanged at beginning and at the end.
2. Either it exchanges $ for Euros at the time required to swap (which is why the exchange rates are disclosed), or it has invested in some kind of business in Europe, or it already has a business in Europe that provides a fixed-rate return. Do remember that the US co will be receiving $ from the Bank, so some kind of "pay the difference" arrangement could be made, so it's not a large amount of swapping going on.
Point is, it doesn't really matter. Please stop worrying about this fictitious company. By the time question #5 rolls around, it will have ceased to exist.

Remember also in this deal how that the amount to be paid next is determined by the current rate. Time 0's 8% rate is paid at Time 1, Time 1's 7.5% rate is paid at Time 2, etc.