Description
(1) Deutsche Bank is into a 5-year fixed-for-LIBOR interest rate swap with Volkswagen on a notional
amount of 10 million with semi-annual payments/ compounding. The bank pays LIBOR for 10%
annually. Volkswagen defaults on the sixth payment, when annual LIBOR was 8% with a flat yield
curve. How much will Deutsche lose, if the six-month LIBOR halfway through Year 3 was 9%
annually?
(2) The spot USD/GBP exchange rate is 1.1832 dollars per pound, the 6-month forward FX rate is
1.1654 and the 6-month USD annual interest rate is 0.8%. What is the 6-month British interest rate
(all compounding is continuous)?
(ii) The 3-month interest rate is 1% in Mexico and 3% in Brazil (continuously compounded), while
the spot price of the Mexican peso is 1.05 real. The price of a 3-month future is the same. Are there
arbitrage opportunities? [10 points]
