US investor buys €1000 EUR 5 yr zero coupon bond. Spot fx 0.93, initial outflow $1075
US investor decides to sells bond at par after 1 year for €1000, Spot fx is now 1.00
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Unehedged scenario: US investor sells €1000 and gets $1000 back at the new spot FX of 1.00, takes $75 of currency loss.
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Hedged with currency swap scenario (assume no discounting): €1000/$1075 principal is exchanged at inception and maturity. US investor unwinds swap early, PV of USD leg $1075, PV of EUR leg is -€1000 * spot FX of 1.00 = -$1000, NPV of unwind proceeds is $75. Investor returns €1000 to the swap counterparty, gets $1075 back with added $75 unwind proceeds = $1150. Records a $75 currency gain.
If the US investor let the bond and currency swap mature naturally, the investor’s net position is zero. He pays €1000 and gets $1075 back, irrespective of where the spot FX rate is at the end of year 5.
So how come if the investor unwinds the swap early, the investor is realising mTm FX gain/losses? Does this imply cross currency swaps carry FX risks if not held to maturity? If so, do investors need to consider the impacts of FX moves before deciding to sell the bond/close out currency swap prematurely?
Thanks