EUR deposits are sold by Sell/Buy EUR/USD swaps and purchased USD.
In this portfolio, first leg(spot transaction) already matured and position carries only the second leg,i.e.forward leg. All these swaps are fixed rate swaps like spot rate(spot transaction) and Forward leg (Forward currency rate = Spot+premium). There are no floting rate swaps. Tenor of the swaps are different to each other and only the contract amounts are added to get the long EUR40Mn position.
How can the daily marking to market profit of this posiiton calculate? How can we hedge this position against rate movement?
PORTFOLIO:
Sell_Buy position - Long EUR 40Mn
( First leg EUR sell and USD buy which is already matured,second leg is outstanding with long EUR position-Buy EUR & Sell-USD)
Buy_Sell position - Short EUR 5 Mn (Vice versa of the above)
Euros are borrowed (and sold) vs USD is bought (and invested). Therefore the position is paying funding cost of borrowing euros and is earning relevant index rate on the USD position.
Changing in borrowing cost of EUR and investment rate of USD are the 2 main factors driving the MTM of this trade (assuming it is not collateralised and hence there is no associated cost for posting or holding collateral)
PS: the terminology you used is technically incorrect and makes your question very confusing and contradictory.
-
its the exchange of notionals upfront - not first leg. It would be called first leg if the underlying trade was FX swap (and not a cross currency basis swap)
-
“All these swaps are fixed rate swaps like spot rate(spot transaction) and Forward leg (Forward currency rate = Spot+premium).” Cross currency swaps are either non-resettable (meaning notional is changed upfront and at the end using the same FX rate) or they are resettable (notional is reset on every coupn date). There is no such thing as Forward leg/Forward rate on a CCBS.
How do we hedge?
You have exposure to EUR borrowing cost (i.e. EONIA curve), USD LIBOR, basis spread and FX. Textbok hedging will be hedging these components in turn but that would wipe out all the profit.
At banks we see positions offsetting some risk, some risk is hedhed imperfectly, some is retained and rest is hedged using IRS, OIS swaps and FX forwards.
Thank you for the explanation!