Suppose that the term structure of risk-free interest rates is flat in the United States and Australia. The USD interest rate is 7% per annum and the AUD rate is 9% per annum. The current value of the AUD is 0.62 USD. Under the terms of a swap agreement, a financial institution pays 8% per annum in AUD and receives 4% per annum in USD. The principals in the two currencies are $12 million USD and 20 million AUD. Payments are exchanged every year, with one exchange having just taken place. The swap will last two more years. Assume all interest rates are continuously compounded.

(a) Draw a diagram to clearly present the cash flow exchange between this financial institution and its swap counterparty. Clearly label the currency, interest rate and direction of cash flow.

(b) Suppose the financial institution had a USD debt before entering the swap. Draw a diagram to indicate how it may have used this swap contract, to turn the USD debt into a net AUD debt.