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Explain the pricing of currency swaps, and work out their no-arbitrage value and say what it means

CFA® Level II · Derivatives and Risk Management · Pricing and Valuation of Forward Commitments · L2.DE.1.f

The idea

A currency swap exchanges notionals at the start and end and interest in two currencies in between. Each fixed rate is set like a swap rate in its own currency: (1 − final discount factor) ÷ sum of discount factors, using that currency's curve. The notionals are linked by the spot rate at inception so the swap starts at zero value. To value it later, price each leg as a bond in its own currency with its own discount factors, including the final principal, convert the foreign leg at today's spot rate, and subtract the leg you pay from the leg you receive. The trap is converting at the original spot rate, or leaving out the principal exchange.

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