Currency Swap: Alibaba Group entered a currency swap with Goldman Sachs three ye

Question

Currency Swap: Alibaba Group entered a currency swap with Goldman Sachs three years ago. According to the contract specifications, every year Alibaba pays 3% in US dollars (USD) on a principal of $30 million and receives 5% in Chinese Yuan (CNY) on a principal of 180 million CNY. The swap will last another 4 years with the next payment due in one year. The term structures of interest rates in United States and China are observed as follows:

What should Goldman Sachs report as the fair value of the contract if the exchange rate is 1 USD = 6.15 CNY?

Maturity US Interest rate Chinese Interest Rate 1 years 2.07 4.03 2 years 2.24 4.27 3 years 2.39 4.38 4 years 2.49 4.57

Explanation / Answer

Receipt per year under swap = $30 million * 3% = $900000

Payment per year under swap = 180 million CNY * 5% = 900000 CNY

Payment per year under swap in $ = 900000/6.15 = $146341

Net Receipt = 900000 - 146341 = $753659

Interest Rate = 2.49%

Fair Value of receipts = 753659 * Cumulative present value @ 2.49% for 4 years

= $2835929

Goldman Sachs should report the fair value of receivable as $2835929.

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