You enter into an equity swap where you receive the US dollar return on the Nikkei index at prevailing exchange rates, and pay dollar Libor. Which of the following statements is most valid?
A) Because the equity leg is paid in dollars there is no exchange-rate exposure in this transaction.
B) There is no currency risk in this transaction only if the correlation of the Nikkei index with the dollar/yen exchange rate is zero.
C) There would be no currency risk in this swap if the interest rate leg were in yen.
D) There would be no currency risk in this swap if the equity leg payment were computed using a fixed exchange rate.

Question

You enter into an equity swap where you receive the US dollar return on the Nikkei index at prevailing exchange rates, and pay dollar Libor. Which of the following statements is most valid? 
A) Because the equity leg is paid in dollars there is no exchange-rate exposure in this transaction.
B) There is no currency risk in this transaction only if the correlation of the Nikkei index with the dollar/yen exchange rate is zero.
C) There would be no currency risk in this swap if the interest rate leg were in yen.
D) There would be no currency risk in this swap if the equity leg payment were computed using a fixed exchange rate.

Quizplus · Accepted Answer

The correct answer is D because using a fixed exchange rate for the equity leg payment eliminates currency risk by locking in the exchange rate at which the returns on the Nikkei index are converted to dollars, regardless of future fluctuations in the actual exchange rate.

You Enter into an Equity Swap Where You Receive the US