April 2010 SP5 Question 5 (iii) Term structure of Swap curve

[Tong_Tong]

Hello,

I am currently reviewing the answers in the revision booklet and I was not sure about the answer in part (iii). I am not sure if I understand the bit about "There may also be a degree of hedging activity in either direction from recipients of relatively certain overseas cashflows who wish to pay fixed GCU rates, or payers of relatively certain overseas cashflows who wish to receive fixed GCU rates. This type of hedge would be more appropriate where the mix of overseas currencies was somewhat unstable, and less appropriate in other cases due to the additional basis risk relative to hedges carried out in currency pairs."

Is this bit saying that people who either hold/or pay out loans in mix of currencies want to swap with GCU payouts/payments because GCU is more stable and the mix of different currencies are more volatile regarding to a mix of different currencies? The down side of swapping a basket of currency cashflows with GCU is that there are additional Basis risk?

Thanks,

 

[Colin McKee]

This was a VERY odd and difficult question, relative to other ST5 questions. I think this part f the answer was the examiner giving examples of traders or companies that might want GCU based swaps. The examples given are people who have currency flows in "fiat" currencies but want to pay (or receive) more stable GCU interest rates. But I suspect any examples of why someone might produce supply or demand for swaps in the GCU would have gained marks (marks for this question were low).