Aussie-Akubra is a US-based subsidiary of an Australian company. A large part of its business is located in the USA. Aussie-Akubra derives income in USD. Lincoln-USA is a subsidiary of a US company based in Australia. Lincoln-USA derives income in AUD. Both subsidiaries have decided to expand their operations in the US and Australia, respectively. Each subsidiary would like to finance its operations by issuing debt into the capital market of its home country.
To what risk, not usually associated with interest rate swap, would the issue of debt expose each subsidiary? Explain how both subsidiaries can use ‘cross-currency swap’ to avoid exposure to the risk identified. In your answer, discuss whether or not the currency-swap would result to a perfect hedge
