A US-based investor enters into an unhedged cross-currency equity swap in which he pays returns on the S&P 500 index in dollars in exchange for receiving the returns on the FTSE 100 in pounds. At inception, the notional principal on the swap is $100 million, and the exchange rate is $1.60 = £ 1. Cash flows are exchanged every six months and the first six-month period has 182 days in it. At the end of the first six-month period, the raw returns on the S&P 500 are 8% and the raw returns on the FTSE 100 are 9%. The exchange rate at this point is $1.50 = £ 1. The investor's net cash flow on this first payment date is
A) $-$ $1million.
B) $+$ 0.165 million.
C) $+$ 0.438 million.
D) $+$ 1 million.

Question

Quizplus · Accepted Answer

The investor's net cash flow can be calculated by considering the returns on both indices and the change in the exchange rate. The investor pays the return on the S&P 500 in dollars and receives the return on the FTSE 100 in pounds, which then must be converted back to dollars at the new exchange rate.1. The investor pays 8% of $100 million for the S&P 500, which is $8 million.2. The investor receives 9% of £62.5 million (since the initial exchange rate was $1.60 = £1, and the notional principal was $100 million, the equivalent in pounds is $100 million / 1.60 = £62.5 million) for the FTSE 100, which is £5.625 million.3. The received amount in pounds is then converted back to dollars at the new exchange rate of $1.50 = £1, resulting in £5.625 million * 1.50 = $8.4375 million.The net cash flow is the difference between what the investor receives and pays, which is $8.4375 million - $8 million = $0.4375 million, or $0.438 million when rounded.

A US-Based Investor Enters into an Unhedged Cross-Currency Equity Swap −-−

A US-Based Investor Enters into an Unhedged Cross-Currency Equity Swap $-$