The reason why, is because these kinds of companies are often exposed to large swings that could happen at any point in time (due to adverse changes in the economy or the markets). This will have a negative effect on earnings and it will become difficult from them to make accurate projections. When a company begins using hedging, this will provide more consistent earnings stability to their business model. This is point that they can provide more stable returns to shareholders. However, not all firms should be hedging. In some cases, this activity could be considered to be speculation. As, the hedge may not provide any kind significant benefit to the business by: addressing a challenge that they are facing. Instead, it is executives using the company's funds to make risky trades. As their business, will see no benefit from: the position other than to receive a financial gain. When this happens, it is a sign that a firm should not be involved in these activities. This is due to the fact that it is: increasing their risks and not supporting the long-term viability of the company.

Question 5

Trident is a multinational corporation that has operations in several countries. Although Trident is based in the U.S. And its profits are reported in USD, its revenues are denominated in various currencies including the AUD. Recently, Trident took out a 3-year USD loan at a fixed interest rate of 3.5% per annum. Since Trident has AUD revenues, it has decided to enter in a three-year swap to receive USD and pay AUD. The...

The notional amount of the swap is USD 10 million with the USD/AUD exchange rate of 0.77.
(a) Calculate the USD loan interest payments

(b) Calculate the AUD principal and interest payments under the swap agreement

(c) Draw the following time lines with their respective values

TRIDENT

USD Loan payments

SWAP

Receive USD

SWAP

Pay AUD

(d) One year into the swap agreement, Trident's operations in Australia have become unprofitable and it has decided to withdraw from the Australian market. Consequently Trident has to unwind the swap as it no longer has the AUD revenue to service the AUD swap payments. At that time the two-year fixed rate on the USD loan is 3.2% per annum and the two-year fixed rate on the AUD loan is 5.5% per annum. The spot rate is USD/AUD 0.75.

(i) Calculate the present value of the remaining USD swap receipts.

(ii) Calculate the present value of the remaining AUD swap payments.

(iii) Calculate the present value of the swap. Hint: the present value of the swap is the difference between the present value of the payments and the present value of the cash flows received discounted at interest rates applicable to each currency.

(iv) For the swap to be discharged, identify who pays whom what?

Bibliography

Thomas, M, 2005, Hedging Instruments and Risks. McGraw Hill, New York.