Explanation:
Answer: C
Reasoning:
Parislaza's concern is that the USD will depreciate against the EUR. Since they are invested in a USD-denominated asset, USD depreciation is BAD for them (it reduces the EUR value of their investment). They need to hedge this risk or take a position that benefits from USD depreciation.
The Currency Swap Solution (Option C):
In a fixed-for-fixed currency swap with principal exchange:
$10.0M USD and receives €8.70M EUR (at spot rate of 1.150)
$10.0M ÷ 1.150 = €8.6956M ≈ €8.70M ✓$0.70M USD per year$10.0M)Why this expresses their belief:
Why the other options are wrong:
(a) Incorrect: USD depreciation does NOT favor a USD-denominated investment. It HURTS the EUR value of the investment. They need protection.
(b) Incorrect: This is a tautology. If USD depreciates against EUR, by definition EUR appreciates against USD. These are two sides of the same coin. This option doesn't address the hedging need.
(d) Incorrect: This swap is "in the wrong direction" in terms of the notional. Since interest rates are identical (7% on both legs), the swap value depends on principal exchange. Paying $0.70M and receiving $0.70M cancels out (no currency conversion). The proper hedge requires the EUR leg of €8.70M principal and €0.61M interest to convert the exposure to euros.
Ultimate access to all questions.
22.15.3. Parislaza Investment Corp is a French money manager who is offered the following (aka, underlying) investment opportunity: they can invest `10.0` million principal will be returned. However, during that period Parislaza has a belief (i.e., a concern) that the dollar will depreciate against its own domestic currency, which is the euro (EUR).
The Fiber's spot exchange (FX) rate is `$1.15`0 EURUSD and—simply for unrealistic convenience—we will assume that interest rates are comparable between the USD and EUR (including identical riskfree rates such that the FX forward curve is conveniently flat. Consequently, fixed-for-fixed currency swaps are available (with an initial zero value to both counterparties) at multiple tenors that swap the initial principal at the current spot rate; pay the same interest rate to both legs, and finally re-swap the same principal amounts at the end.
If Parislaza takes advantage of the U.S. dollar investment opportunity, which of the following derivatives is the best trade (in addition to the underlying investment) that expresses its specific belief that the dollar will depreciate against the EUR?
a) No additional trade because USD depreciation already favors the underlying investment b) No additional trade, but only if Parislaza additionally believes that the EUR will appreciate against the USD c) Enter into a fixed-for-fixed currency swap with principal of €8.70 million EUR to receive interest of €0.61 million EUR per annum d) Enter into a fixed-for-fixed currency swap with principal of `10.0` million USD to receive interest of \`0.70` million USD per annum
A
No additional trade because USD depreciation already favors the underlying investment
B
No additional trade, but only if Parislaza additionally believes that the EUR will appreciate against the USD
C
Enter into a fixed-for-fixed currency swap with principal of €8.70 million EUR to receive interest of €0.61 million EUR per annum
D
Enter into a fixed-for-fixed currency swap with principal of `10.0` million USD to receive interest of \`0.70` million USD per annum
No comments yet.