Derivatives TT - Whitney

CFA Level II Derivatives
#1

Hello,

Can anyone confirm if the answer to question 5 on TT Whitney is correct/incorrect? They are showing a negative swap value for Grant, but with the HK$ appreciating vs the EUR, i would expect the value of the contract to Grant to be positive since he is Hong Kong based paying EUR denominated interest payments, and the final return of principal would be less HK$. Also, the explanation provided by the CFAI shows the answer as a positive value, but the available answers only show it as negative. I’m concerned if the answer is truly negative, then my logic of working through this problem is flawed.

Please advise

Thanks!

#2

Grant requires EUR to finance a project in Germany, Europe. The interest rate in EUR is quite high since Grant is based in Hong Kong. So Grant borrows in HKD and sells HKD spot at 11.42 HKD/EUR. Next, HKD appreciates versus EUR, so Grant requires more EUR to pay back the loan in HKD, which implies a negative swap value. The error in the TT is that they forgot to add a minus sign in the solution example.

#3

This just doesn’t make sense to me, for two reasons.

  1. we are valuing the swap between the euro fixed payer and the HK$ fixed payer. My understanding is that the value of the swap should be the PV of the cash flows between the two parties. Grant is paying euros, so the cashflow out should be the PV of the quarterly coupon payments and the final principal. This is approx. 24.4mm Euros. The cashflow flow in should be the PV of the HK$ coupon (which is fixed at inception) and the principal that was swapped at inception. The Euro denominated value of this using the current spot rate is approx. 28mm. So my cash in exceeds my cash out, which would result in a gain.

  2. even if we are taking into consideration the borrowing in HK$, we are receiving HK$ fixed interest and principal payment, which will be equivalent to what is due back to the bank. If i borrowed 285mm from the bank and swapped 285mm HK$ for 25mm EUR with a Euro bank, when i unwind my swap, i will give back 25mm EUR, and they will give back 285mm HK$.

This is how i work through this problem, could you explain where i’m going wrong? Much appreciated