Explain how the transaction can be fairly priced

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Reference no: EM13925856

Consider a currency swap with but two payment dates, which are one year apart, and no exchange of notional principals. On the first date, the party pays U.S. dollars at a rate of 4 percent and receives British pounds at a rate of 3.5 percent. Since the payments are annual, no adjustment, such as days/360, is necessary. The notional principals are $10 million and £6.25 million. Explain from an American's perspective how this transaction is like a series of forward contracts on the pound. Also, explain how the transaction can be fairly priced, which you can assume it is, even though the implied forward rate is the same for both maturities.

Reference no: EM13925856

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