In a currency swap, you are betting against exchange rate. Now,while pricing a currency swap, what are we determining? Are we determining that single exchange rate which shall equate the future cash flows in two currencies given the fixed swap interest rates. Or we determining the swap interest rates both the currencies which will equate the cash flows. IN other words, would the swap interest rate already factor the currency exposure & hence pricing of currency swap means deriving swap interest rates for two currencies?
You’re determining the payments that give a present value of zero given the prevailing spot curves in each currency and the current (spot) exchange rate between the currencies.
But how are we determining those payments? Cash flows are function of interest rate and exchange rate. Are you suggesting that each cash flow in determined based on 1) fixed swap interest rates and 2) converted into currency using at sport curve
No matter the type of swap, the fixed rate is calculated the same way.
Thanks for efforts. Could you please elaborate how are the payments determined?
Fixed\ rate = \frac{1 − Z_n}{\sum_{i=1}^n Z_i}
where Z_i is the discount factor for the payment at time i