Australian Wood Chip Ltd (AWC Ltd) has signed a contract to sell USD 50,000 p.a. of wood pulp to Japan every year for the next 10 years. The company wants to hedge its foreign currency risk and therefore enters a fixed for fixed currency swap with its bank at a swap rate of AUD 5% p.a. in exchange for USD 5% p.a. The exchange rate at commencement of the swap is USD1=AUD1.2.

Answer ALL of the following questions:

1. What is the amount and currency of the principal that is exchanged between the bank and AWC Ltd at commencement and end of the swap?
2. What is the net income that AWC Ltd receives on its hedged position?
3. In your own words, discuss how effective the hedge will be at reducing foreign exchange risk and suggest any alternative or additional treatment options.