Explanation

This is a currency swap valuation problem where we need to calculate the value from the perspective of the party paying pounds and receiving euros.

Key Information:

• Pounds paid: 3% semi-annual on £1,000,000
• Euros received: 2% semi-annual on €1,100,000
• Remaining periods: 4 (0.5, 1, 1.5, 2 years)
• Risk-free rate (pounds): 2.5% semi-annual
• Forward exchange rates: 1.1443, 1.1387, 1.1330, 1.1275 €/£

Calculation Steps:

1. Calculate Pound Cash Flows (Outflows):

   • Semi-annual interest: £1,000,000 × 3%/2 = £15,000
   • Final principal: £1,000,000

2. Calculate Euro Cash Flows (Inflows):

   • Semi-annual interest: €1,100,000 × 2%/2 = €11,000
   • Final principal: €1,100,000

3. Convert Euro Cash Flows to Pounds using Forward Rates:

   • Period 0.5: €11,000 / 1.1443 = £9,613.21
   • Period 1: €11,000 / 1.1387 = £9,659.26
   • Period 1.5: €11,000 / 1.1330 = £9,708.74
   • Period 2: €11,000 / 1.1275 = £9,756.10
   • Final principal: €1,100,000 / 1.1275 = £975,610.20

4. Calculate Present Value using Pound Risk-Free Rate (2.5% semi-annual):

   • Discount factor = 1/(1 + 2.5%/2)^(2×t)
   • PV of Pound outflows: £15,000 × (DF₁ + DF₂ + DF₃ + DF₄) + £1,000,000 × DF₄
   • PV of Euro inflows (converted): Sum of PV of converted cash flows

5. Swap Value = PV(Inflows) - PV(Outflows):

   • The calculation yields approximately -£43,824.76

Interpretation:

The negative value (-£43,824.76) means the swap has negative value for the party paying pounds, indicating they are paying more than the current market rate for this swap arrangement.