Explanation:
When the dollar appreciates against the GBP, the value of the GBP-denominated cash flows received by Black Corporation (which pays 5% in GBP and receives 7% in USD) effectively becomes more valuable in USD terms. Since Black is receiving USD payments and paying GBP, an appreciation of the dollar means Black's USD payments are worth relatively more while its GBP obligations are relatively cheaper. This increases the value of the swap to Black Corporation. Conversely, the value of the swap to UK Fabrics decreases. Therefore, Option A is correct - the value of the swap to Black Corporation will increase.
Additionally, swap values are affected by changes in exchange rates, foreign interest rates, and domestic interest rates, so Option D is incorrect.
Q.719 Black Corporation and UK Fabrics have entered into a 3-year currency swap agreement with periodic annual payments, where Black agreed to pay 5% in British pound (GBP) on the principal amount of GBP 100 million to UK Fabrics. In addition, UK Fabrics agreed to pay 7% to Black on the principal of $120 million. The currency exchange rate at the initiation of the swap was USD 1.26 per GBP. If the interest rate in the United States and Great Britain are flat at 5.5% and 6.8%, respectively, but the dollar has appreciated in value against the GBP, then determine which of the following is true.
A
The value of the swap to Black Corporation will increase.
B
The value of the swap to UK Fabrics will increase.
C
The value of the swap to both the companies will increase.
D
The value of the swap will be unaffected by subsequent changes in exchange rates.
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