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Answer: The hedge fund will pay CNY 65 million and receive USD 10 million at the initiation of the swap.
**B is correct.** With a currency swap, the notional amounts are exchanged in an opposite direction from the interest rate payments at the initiation of the swap. Therefore, if the hedge fund is collecting interest in CNY, it will pay CNY 65 million and receive USD 10 million at the initiation of the swap. **A is incorrect.** Unlike an interest rate swap, the principal amounts are actually exchanged at the initiation of a currency swap. **C is incorrect.** The swap will typically have a zero mark-to-market value upon initiation. **D is incorrect.** Since the hedge fund initially pays CNY and receives USD, at the end of the swap the fund will pay USD and receive CNY. If the CNY depreciates in the meantime, the fund would receive less on settlement than it would have if it simply converted the USD to CNY in the spot market, so the mark-to-market value would decrease.
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A currency derivatives trader at a hedge fund is describing the mechanics of currency swaps to a group of junior analysts. The trader uses an example of a fixed-for-fixed USD for CNY currency swap with the following terms:
Assuming the hedge fund receives interest in CNY, which of the following conclusions would the analysts find to be most likely correct?
A
Interest payments will be exchanged periodically for the duration of the swap, but the notional amounts will not be exchanged.
B
The hedge fund will pay CNY 65 million and receive USD 10 million at the initiation of the swap.
C
The swap is structured to have a positive mark-to-market value for the hedge fund at the initiation of the swap.
D
Holding all else constant, if the CNY depreciates against the USD, the mark-to-market value of the swap will increase for the hedge fund.
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