Suppose the U. S. yield curve is flat at 3% and the euro yield curve is flat at 4%. The current exchange rate is $1.35 per euro. What will be the swap rate on an agreement to exchange currency over a 3-year period? The swap will call for the exchange of 2.1 million euros for a given number of dollars in each year. (Do not round intermediate calculations. Enter your answer in millions rounded to 4 decimal places.)

2.7814 millions per year

Explanation:

The rate that is determined by the contracting parties of a swap is known as swap rate.

The swap rate is decided by the receiver and paid by the payer in order to compensate the uncertainty bear by the receiver related to the fluctuations in floating rate.

Amount Delivered = Forward Exchange Rate * Exchange Amount

Year 1  

= $1.35 * ( 1.03 / 1.04 ) * Euro 2.1 million

= $2.8077 millions

Year 2

= $1.35 * ( 1.03 / 1.04 )∧2 * Euro 2.1 million

= $2.7807 millions

Year 3  

= $1.35 * ( 1.03 / 1.04 )∧3 * Euro 2.1 million

= $2.7540 millions

Now Swap per year =

[F/(1+0.3) + F/(1+0.03)∧2 + F/(1+0.03)∧3 ]= [ $2.8077 ( 1+0.03)∧2 + $2.7807 (1+0.03) + $2.7540 ] / ( 1+0.03)∧3

= F [ 2.8286 ] = 7.8674

F = 2.7814 millions per year

answer; is usually (less than) the socially optimal level of consumption;