Terry Guo is a risk analyst for Foxconn, a Taiwanese multinational electronics contract manufacturer. Recently, Foxconn took out a NTD30 million, five-year, floating-rate bank loan which requires semi-annual payments of interest based on TAIBOR(Taipei Interbank Offered Rate) plus a spread of 5 percent and repayment of principal at maturity. Terry expects that interest rates will rise in the near future and worries that Foxconn may not be able to absorb the higher loan costs due to an increase in rates. He proposes that he will convert the loan to a 11.70 percent fixed rate by entering into the pay-fixed of a five-year, NTD30 million notional principle interest rate swap with semi-annual payments that exchanges TAIBOR for a fixed rate of 11.70 percent. He explains that the swap will act as a hedge to reduce the company's net cash flow risk and net market value risk.

(NTD stands for New Taiwan Dollar)

(1) Is Terry's explanation of his plan to convert the five-year loan from floating to fixed correct? Provide justification for your answer. (5 marks)

(2) Is Terry's characterization of the interest rate swap as a hedge for the bank loan correct? Provide justification for your answer. (5 marks)