A state government borrowing authority is to issue USD bonds as part of the government’s capital funding program. The borrowing authority plans to establish an intermediated crosscurrency swap in order to convert the USD principal amount raised into AUD and, at the same time, manage the FX risk exposures attached to the future USD bond coupon payments.
(a) Draw and fully label a diagram of the flows at:
(i) the commencement of the swap
(ii) the first interest coupon payment date
(iii) the contract completion date.
(b) Explain how the cross-currency swap allows the borrowing authority to hedge its interest rate risk and FX risk exposures. (LO 18.6)