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9% Can $ 11.0% £
9% Can $ 11% £
A F.I. B
10.4% £ 9.7% Can $
5.62
5.57 0 x 12
0x9
5.50
0x6
5.42
spot
0 6 9 12 Months
Implied Forward Rates
• We can use these LIBOR rates to solve for the
implied forward rates
– The rate expected to prevail in three months, 3f6
– The rate expected to prevail in six months, 6f9
– The rate expected to prevail in nine months, 9f12
2
0 f 3 3 f 6 0 f 6
1 + 1 + = 1 +
4 4 4
Implied Forward Rates
(cont’d)
• Using the available data:
2
.0542 3 f 6 .0550
1 + 1 + = 1 +
4 4 4
3 f 6 = 5.58%
Implied Forward Rates
(cont’d)
• Applying bootstrapping to obtain the
other implied forward rates:
– 6f9 = 5.71%
– 9f12 = 5.77%
Implied Forward Rates
(cont’d)
LIBOR forward rate curve
5.77
5.71 9 x 12
6x9
5.58
3x6
5.42
spot
0 3 6 9 12 Months
Valuation of Currency Swaps
In a currency swap the principal is exchanged at
the beginning and the end of the swap. Therefore,
currency swaps can be valued either as the
difference between 2 bonds or as a portfolio of
forward contracts
• Value of Swap (Vs) = Value of the debt security
in foreign currency (Bf) X Spot Exchange rate (S)
- - Value of the debt security in home currency
(Bh)
Illustration
The following information is taken from the books of
a bank relating to an interest rate swap
Remaining term to maturity 3 years
Fixed rate paid by bank 10%
Floating rate received by bank 6m LIBOR
Current 6m LIBOR 9%
Market quote for 3 year swap 10.5% semi-annual vs.
LIBOR
Find out the value of the swap, if bank has received
the latest interest payment.
Risk Behind Swaps