CFA Level IDerivativesMedium
Company A enters a fixed-for-fixed currency swap, paying a fixed 4% on a $10 million USD notional and receiving a fixed 3% on a €9 million EUR notional annually. At the first annual settlement date, the spot exchange rate is $1.15 per euro. What is the net cash flow to Company A at this settlement date (ignoring notional exchange)?
- ACompany A receives $89,500 net
- BCompany A pays $89,500 net
- CCompany A receives $310,500 net
- DCompany A pays $130,000 net
Show answer & explanationAnswer & explanation
Correct answer: B. Company A pays $89,500 net
Company A owes USD interest of 4% × $10,000,000 = $400,000, and receives EUR interest of 3% × €9,000,000 = €270,000, which converts to €270,000 × $1.15 = $310,500. Netting: $400,000 owed − $310,500 received = $89,500 net payment by Company A.
Why the other options are wrong
- A. This reverses the direction of the net cash flow.
- C. This is only the converted EUR receipt, not the net after subtracting USD owed.
- D. This uses the wrong interest amounts, not the actual currency-specific payments.
Fixed-for-Fixed Currency Swap Settlement
In a fixed-for-fixed currency swap, each party pays interest in its own notional currency; net settlement requires converting one leg to a common currency using the spot rate.
- Each leg's interest is calculated on its own currency notional
- Convert one currency's cash flow using the prevailing spot rate to net
- Currency swaps typically also exchange notional principal at initiation and maturity
Memory trick: Two currencies, one settlement — convert, then net the difference.