The aim of this case study is to illustrate the hedge of a net investment in a foreign operation with a floating-to-floating CCS. ABC, a group with presentation currency the EUR, decided to enter into this type of CCS because the USD interest rate curve was markedly steep. When curves are very steep, short-term rates are notably lower than long-term rates, and entities paying a floating rate experience substantial savings relative to paying the fixed rate during the initial interest periods.

Suppose that ABC's objective was to hedge USD 500 million of its investment in its US subsidiary SubCo over the next 3 years. The terms of the CCS were as follows:

Cross-currency swap terms
Start date 1 January 20X0
Counterparties ABC and XYZ Bank
Maturity 31 December 20X2
EUR notional EUR 400 million
USD notional USD 500 million
Implied FX rate 1.2500
ABC pays USD 12-month Libor + 10 bps annually, actual/360 basis, on the USD nominal
ABC receives 12-month Euribor annually, actual/360 basis, on the EUR nominal
Final exchange On maturity date, there would be a EUR cash settlement amount based on the EUR–USD fixing prevailing on such date (i.e., there would be no notionals exchange)Settlement amount = 400 mn – 500 mn/EUR–USD fixingIf the settlement amount were positive, ABC would receive the settlement amountIf the settlement amount were negative, ABC would pay the absolute value of the ...

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