International Financial Management 6th Edition by Sanjiv Eun, Cheol Resnick, Bruce Sabherwal

Exercise 21

A company based in the United Kingdom has an Italian subsidiary. The subsidiary generates €25,000,000 a year, received in equivalent semiannual installments of €12,500,000. The British company wishes to convert the euro cash flows to pounds twice a year. It plans to engage in a currency swap in order to lock in the exchange rate at which it can convert the euros to pounds. The current exchange rate is €1.5/£. The fixed rate on a plain vanilla currency swap in pounds is 7.5 percent per year, and the fixed rate on a plain vanilla currency swap in euros is 6.5 percent per year.
a. Determine the notional principals in euros and pounds for a swap with semiannual payments that will help achieve the objective.
b. Determine the semiannual cash flows from this swap.