3420), adjusted for the difference between the two interest rates, by selling the USD in a one-month forward contract. Hence the AUD proceeds of its clients are not exposed to the risk of a possible appreciation in the AUD over the next month. But the investor clients will not benefit should the AUD depreciate over the month.
Effects of hedging the FX risk on a foreign currency loan
As explained above foreign currency liabilities face the risk that the domestic currency depreciates prior to their repayment. This risk can be hedged with a sell/buy FX swap undertaken when the funds are borrowed. The FX swap would convert the funds into the domestic currency (selling the borrowed foreign currency at the spot rate) and exchange them back into the foreign currency (buying forward at the forward rate) when the loan is to be repaid.
The effects of the FX swap are to hedge the borrowers FX risk but in the process this offsets the difference between the domestic and foreign interest rates. View More »