Hi, can you please help me understand the below currency swap question taken from the Schweser book?
Q: The current to C FX is 0.7. In a 1 million fixed-for-floating currency swap. the party that is entering the swap to hedge existing exposure to a C-denominated fixed-rate liability will:
A. received $1 million at the termination of the swap.
B. oat a fixed rate based on the yield curve in the US
C. receive a fixed rate based on the yield curve in Canada
ANSWER: A receive-fixed C$ position will hedge the liability risk. That party would receive $1 million at swap inception and pay it back at termination. The fixed-rate received will be calculated using the yield curve in Canada at the initiation of the swap. Because this is a fixed-for-floating currency swap, the receive-fixed position will pay a floating rate based on the US yield curve.
ME:
First of all, if the party wants to hedge exposure to a C$ liability, does it mean that it has the C$ liability/ own someone C$ and want to hedge the currency & interest rate risk?
That would explain why the answer reads that a receive-fixed C$ position will hedge the risk (because I lock my rate). But then, why the following sentence reads that the party will receive ? Should not the party receive C?
If you read further and assume that the party indeed received , why it pays interests on C? I though that what happens here is that each party effectively borrows on the other’s behalf, thus if I receive , I pay interests in .
Thanks!