The Reserve Bank of Australia and the US Federal Reserve have established a temporary swap line for the provision of US dollar liquidity. The swap line allows the Reserve Bank to access up to US$60 billion in exchange for Australian dollars. The US dollars are made available to financial institutions operating in Australia via repos with the Reserve Bank.

Question

a.Use the knowledge you learned from risk management course, explain to Jayden about swaps and the repo rate, and how it can be used in supporting US dollar funding.

b. Commonwealth Bank of Australia has entered into an interest rate swap with Virgin Airline three year ago. Under the terms of the swap, it receives 3% per annum and pays six-month LIBOR on a principal of $5 million for five years. Payment are made every six months. However due to the travel bans and isolation requirements to prevent the spread of coronavirus, many routes are cancelled, Virgin airline is facing some liquidity issues and failed on the sixth payment when the LIBOR interest rate (with semiannual compounding) is 2.4% per annum for all maturities. What is the loss to the financial institution? Assume that six-month LIBOR was 2.5% per annum halfway through year 3. Use LIBOR for discounting.