Interest Rate Swap Strategies for Hedging Debt Exposure

Company XYZ, a multinational corporation, is concerned about its exposure to fluctuating interest rates due to its significant floating-rate debt and subsequent variable cash flows. The Chief Financial Officer (CFO) is considering a strategy using interest rate swaps to hedge this exposure. Currently, the company pays a floating rate of LIBOR + 200 basis points on its debt and wants to convert this into a fixed rate to stabilize its cash flows.

Assuming the current market conditions allow for a fixed rate swap at 3.5% for a 5-year term, please discuss the following:

1. Describe how an interest rate swap works and the mechanics involved in entering into such a swap.
2. Evaluate the potential benefits and drawbacks of utilizing this swap strategy for Company XYZ.
3. Analyze the impact of potential future interest rate movements on the efficacy of the swap strategy employed by the company.

Support your discussion with relevant examples and economic reasoning.