Solutions to FX Swap Case Study

nullnullHan Yan, Li Qian, Ma Rui, Yuan Fangning, Yang Yan *nullDotcom Company approaches Mega bank to enter into purchase GBP 100,000 against SGD on a 3 months' forward. You are a trainee dealer at MEGA bank and you are being asked by your senior dealer to provide a quote to Dotcom Co. with a profit margin of 35 basis points, and to hedge the position. You check the rates on the Reuters screen and with your swap dealers, and find the following: GBP/USD Spot 1.9010 - 20 USD/SGD Spot 1.6050 - 60 GBP/USD 3-month Swap 100 - 95 USD/SGD 3-month Swap 50 - 45 CASE-1nullA) Give the quotation to Dotcom Company, and describe the transactions to hedge this position using the swap market and spot FX market.CASE-1-> Long USD/SGD -> Long GBP/USD-> 1.6060-0.0045 =1.6015-> 1.9020-0.0095 =1.8925Long GBP/SGD 1.6015*1.8925 =3.0308FEC rate = 3.0308 + 0.0035 = 3.0343Solution3-mon forward = Spot- Forward marginnullB) Three months later Dotcom Company approaches you and requests to extend the forward contract for another 1 month. You senior dealer approves Dotcom's request and asks you to extend the contract. You find that the rates prevailing now are   GBP/USD Spot 1.7310 - 20 USD/SGD Spot 1.5920 - 30 GBP/USD 1-month Swap 40 - 35 USD/SGD 1-month Swap 15 - 10CASE-1null1. What is the new contract rate?SolutionStep 1Short GBP/SGD -> Short GBP/USD -> Short USD/SGD 1.7315*1.5925=2.7574 -> 1.7315 -> 1.5925SpotShort GBP/SGD = 2.7574 (Spot)Loss = 100,000*(2.7574 – 3.0343) = 27,690CASE-13-mon1-monSpot settleEnter FECnull-> Long USD/SGD ->Long GBP/USD-> 1.5925-0.0010 =1.5915-> 1.7315-0.0035 =1.7280Long GBP/SGD 1.5915*1.7280 = 2.7501FEC rate = 2.75011-mon forwardStep 2CASE-1null2. Dotcom Company heard of historic rate rollover and requested you to rollover its position based on historical rate. What should be the new contract rate? (Assume the relevant interest rate for SGD is 5% p.a.)3-mon1-monRollover Enter FECHist. FEC value to Mega = Loss to Dotcom = 0.27690.2769*(1+5%/12) = 0.2781Future ValueNew Contract rate = 1-mon FEC + FV of Hist.FEC = 2.7501 + 0.2781 = 3.0282 SolutionCASE-1null3. Such practice is discouraged by Monetary Authority of Singapore (MAS). Why do you think that MAS discourages the practice of allowing customers to rollover outstanding foreign exchange position at historical rate?SolutionDelay payoff at T1 to T2 - Normal Business (Uncertainty of the delivery date) -  avoid the cash outflows which might occur if the P/L on the forward hedge does not coincide with the currency P/L on the underlying commercial transaction. - Fraud purposes -  to conceal losses, evade taxes…CASE-1nullA) The 6-month (181 days) GBP interest rate is currently trading at 10.00 - 10.125% p.a. and the 6-month (181 days) USD interest rate is trading at 4.125 - 4.25% p.a. in the money market. In the swap market the 6 months swap for GBP/USD is currently trading at 491/470. The GBP/USD spot rate is 1.7500. Do you think there is any arbitrage opportunity between the swap market and money market?CASE-2Step1: Borrow GBP£1M @10.125% for 6months Step2: Short GBP @Spot 1.7500 against USD & Enter FEC Long position @1.7030(1.7500-0.0470) Step3: Lend USD$1.75M @4.125% for 6months Step4: Execute FECSolutionnull-GBP 1 MGBP -1.0502M USD +1.7862MUSD + 1.75 M Current6 monthSpotLong ForwardLend 4.125%Borrow 10.125%GBP +1.0502M@1.7030Loss: -$0.0023MCASE-2 USD -1.7885M nullB) The GBP/USD swap rate has shifted to 528/518 but the interest rates of both currencies remain unchanged. Suppose the spot rate is still trading at 1.7500. Please carry out an arbitrage to profit from the above. The amount you are allowed to trade is GBP 10 million. What will be the profit in USD? Step1: Borrow GBP£10M @10.125% for 6months Step2: Short GBP @Spot 1.7500 against USD & Enter FEC Long position @1.6982(1.7500-0.0518) Step3: Lend USD$1.75M @4.125% for 6months Step4: Execute FECSolutionCASE-2null-GBP 10 MGBP -10.502M USD +17.863MUSD + 17.5 M Current6 monthSpotLong ForwardLend 4.125%Borrow 10.125%GBP +10.502M@1.6982CASE-2 USD -17.834M Loss: $0.0289MnullThank You Q&AThe End