FRM Part I · FRM Exam Part I · Swaps
A US corporation has issued a EUR-denominated fixed-rate bond and wants to hedge both the EUR coupons and the EUR principal repayment against exchange-rate movements. Which currency swap position is most appropriate?
The corporation should receive EUR fixed and pay USD fixed, with principals re-exchanged at maturity. The EUR inflows from the swap fund the EUR bond coupons and principal, and the corporation's net obligation becomes USD payments, effectively converting the EUR liability into a USD liability.
- AReceive EUR fixed and pay USD fixed, with principals re-exchanged at maturityCorrect
- BReceive USD fixed and pay EUR fixed, with principals re-exchanged at maturity
- CReceive EUR floating and pay EUR fixed in a single-currency swap
- DPay USD fixed and pay EUR fixed, with no principal exchange
Explanation
The corporation owes EUR coupons and principal, so it needs EUR inflows that match them; the swap supplies these by receiving EUR fixed and re-exchanging EUR principal. It pays USD, which matches its home-currency revenues and so converts the liability into a USD one. The reverse position would double the EUR exposure. A single-currency swap leaves the currency risk in place.
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