MOD5-SWAPS.pptx

8/16/2019 MOD5-SWAPS.pptx

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MODULE 5: SWAPS

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Contents

• Interest rate swaps

• Currency swaps

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Interest Rate Swaps

• It is an aree!ent "etween two parties toe#c$ane interest pay!ents in a speci%ccurrency &or a speci%c !aturity on an aree'upon notiona( principa(

• )otiona( i!p(ies t$at t$e principa( is at$eoretica( *a(ue use' &or interest ca(cu(ation

• It is a re&erence a!ount on w$ic$ interest is

ca(cu(ate' + $ence it is sa!e &or "ot$ parties

• ,$e principa( a!ount is ne*er e#c$ane'

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Interest Rate Swaps

• Most swap transactions &a(( wit$in 2 +1. year !aturity perio's

• ,wo !ain types:

1/ 0i#e' &or 0(oatin rate swap: a(soca((e' Coupon swaps

2/ 0(oatin &or 0(oatin rate swap:interest pay!ents "ase' on'ierent re&erence rates: a(so ca((e'

asis swaps 3


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IRS: E/ A'apte' &ro! A(an S$apiro

•Parties A 4 "ot$ reuire USD 1.. ! &or a 56year perio'/ Party A $as a cre'it ratin o& w$ereas Party $as a ratin o& AAA

• A wou(' (i7e to "orrow at a %#e' rate w$ereas wou(' (i7e to "orrow at a 8oatin rate

• A can raise &un's at a %#e' rate o& 9/5 or at a8oatin rate o& ;6!ont$ LIOR < ./5

• can raise &un's at a %#e' rate o& =/. or at a8oatin rate o& ;6!ont$ LIOR

• Structure a swap transaction "etween A 4

t$at is !utua((y "ene%cia( to t$e! 5


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IRS: A'apte' 0ro! E/ &ro! A(anS$apiro

BorrowingParty

FixedRateAvailable

FloatingRateAvailable

A: rate' 9/5 ;6!ont$LIOR <./5

: AAA rate' =/. ;6!ont$LIOR

Dierence: A

6

1/5 ./5

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IRS: E/

•Co/ wit$ superior cre'it ratin $as ana'*antae o*er Co/ A in "ot$ %#e' rate!ar7et 4 8oatin rate !ar7et

•

>owe*er ?s a'*antae o*er A is reater int$e %#e' rate !ar7et "ecause t$e cre'itsprea' "etween 4 AAA ratins is $i$er4 !ore "ene%cia( &or t$ere

• A?s 'isa'*antae wrt is (esser in t$e8oatin rate !ar7et "ecause t$e cre'itsprea' "etween 4 AAA ratins is (ower 4

!ore "ene%cia( &or A t$ere =


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IRS: E/

• ,$e a'*antae w$ic$ $as o*er A in "ot$!ar7ets is ca((e' a"so(ute a'*antae + it ist$e a'*antae per se wit$out anyco!parison wit$ ot$er !ar7ets

•A co!parison "etween t$e a"so(utea'*antaes @ 'isa'*antaes across !ar7etsis ca((e' Co!parati*e a'*antae

• I& %r! $as a $i$er a"so(ute a'*antae in!ar7et 1 t$an in !ar7et 2 t$en is sai' to$a*e a co!parati*e a'*antae in !ar7et 1

• I& %r! A $as a (ower a"so(ute 'isa'*antae

in !ar7et 2 t$an in !ar7et 1 t$en A is sai'9


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IRS: E/

• Co/ wit$ superior cre'it ratin $as ana"so(ute a'*antae o*er Co/ A in "ot$ %#e'rate !ar7et 4 8oatin rate !ar7et

•

$as a co!parati*e a'*antae in t$e %#e'rate !ar7et "ecause its a"so(ute a'*antaeis $i$er 4 !ore "ene%cia( &or itse(& t$ere

• A $as a co!parati*e a'*antae in t$e8oatin rate !ar7et "ecause its a"so(ute'isa'*antae is (ower 4 !ore "ene%cia( &oritse(& t$ere


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IRS: E/ : W$at s$ou(' t$e %r!s 'oB

• Eac$ %r! s$ou(' "orrow in t$e !ar7et inw$ic$ it $as a co!parati*e a'*antae

• s$ou(' "orrow in %#e' rate !ar7et 4 A

s$ou(' "orrow in 8oatin rate !ar7et• Interest sa*ins 1/5 6 ./5 1/.

• ,$en t$ey s$ou(' s$are t$e "ene%ts in

ter!s o& sa*ins in interest pay!ents "ye#c$anin swap pay!ents

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• Since A pre&ers a %#e' rate &un'in its$ou(' pay a !a#i!u! 9/5 %#e'

• Since pre&ers a 8oatin rate &un'in it

s$ou(' pay a !a#i!u! ;6!ont$ LIOR• Since A 4 "ot$ are "orrowin aainst

t$eir nee's t$ey can use swap to con*ert

t$e "orrowin into one t$at suits t$eirnee's

• Potentia( interest sa*ins &ro! swap

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• Potentia( interest sa*ins &ro! swap 1• I& t$ey s$are t$e "ene%ts eua((y t$en

eac$ one wou(' re'uce interest rates "y

./5• 0or A: Eecti*e cost o& %#e' rate %nancin

a&ter t$e swap s$ou(' "e: 9/5 6 ./5

9• 0or : Eecti*e cost o& 8oatin rate

%nancin a&ter t$e swap s$ou(' "e:LIOR + ./5

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A

0(oatin

rate(en'ers

0i#e' rate(en'ers

LIOR <./5

=

LIOR

=/5

)et Cost LIOR <./5 < =/5 6

LIOR 9/.

)et Cost LIOR < = 6 =/5

LIOR + ./5 1-


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IRS: Cost o& Inter!e'iation

• In t$e pre*ious swap transaction you$a*e acte' as a consu(tant an'structure' t$e swap

• >owe*er you 'i' not ta7e any &ee

• Suppose you represent Ma# an7

•

Ma# an7 wou(' c$are a &ee o&./1. &or t$e a"o*e ser*iceF arees to sacri%ce ./25G A wants

a''itiona( "ene%t o& ./15 13


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IRS: Wit$ Inter!e'iary C$arin 0ee

A

0(oatin

rate(en'ers

0i#e' rate(en'ers

LIOR <./5

=

LIOR

=/-5

)et Cost LIOR <./5 < =/-5 6

LIOR =/95

)et Cost LIOR < = 6

=/25 LIOR +

./25

Ma#an7

LIOR

=/25

)et Pro%t =/-5 <LIOR + LIOR +=/25 ./1.

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Currency Swaps

•

Desine' to !anae "ot$ interestrate 4 e#c$ane rate ris7s

• In*o(*es an e#c$ane o& 'e"t

ser*ice o"(iations DSO'eno!inate' in 'ierent currencies

• Cas$ 8ows re(atin to t$e DSO o&'e"ts 'eno!inate' in 'ierentcurrencies are swappe' to eect

cas$ 8ows in a 'esire' currency 1;


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Currency Swaps

• ,$e two (oans t$at co!prise currency swap$a*e para((e( interest 4 principa( repay!entsc$e'u(es

• At eac$ pay!ent 'ate interest in one

currency is e#c$ane' &or interest inanot$er currency

• Counterparties a(so e#c$ane principa(

a!ounts at t$e start 4 en' o& swap• ecause t$e perio'ic e#c$ane o& currencies

is %#e' t$e currency swap is eui*a(ent to apac7ae o& &orwar' contracts in currencies

1=


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Currency Swaps CS

•

Counterparties in a CS areconcerne' a"out t$eir a((6in6costAIC

•AIC is t$e eecti*e interest rate ont$e !oney t$ey $a*e raise' w$ic$ iseua( to t$e 'iscount rate at w$ic$

t$e present *a(ue o& &uture interest4 principa( pay!ents is eua( to t$enet procee's recei*e' "y t$e issuer

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Currency Swaps CS

•

Ri$t to oset: Eac$ party $as t$eri$t to oset any non6pay!ent o&principa( or interest wit$ a co!para"(enon6pay!ent

• ,$is is reuire' in or'er to re(ease oneparty &ro! t$e contractua( o"(iations

w$en t$e ot$er party $as 'e&au(te'• A currency swap is not a (oan + so it

'oes not appear as a (ia"i(ity on t$e

"a(ance s$eets o& t$e counterparties1


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Currency Swaps CS

•

MaHor 'ierence "etween CS 4IRS is t$at in a CS t$ere is a(waysan e#c$ane o& principa( a!ounts

at t$e "einnin 4 at !aturity ata pre'eter!ine' e#c$ane rate

• Swap contract "eco!es (i7e a(on6'ate' &orwar' e#c$ane ratecontract w$ere t$e &orwar' rate is

t$e current spot rate 2.


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Currency Swaps CS

•

0i#e'6&or6%#e' CS• 0i#e'6&or68oatin CS

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E: 0i#e'6&or60i#e' CS: E/ &ro! S$apiro

• Dow C$e!ica( DC $as so!e e#posure in Euro

4 wants to $e'e t$e sa!e "y "orrowin inEuro

• Mic$e(in MC wants to %nance its new

in*est!ents in US "y USD (oan• DC can raise USD 'e"t at a coupon rate o&

=/5 or Euro 'e"t at a coupon rate o& 9/25

• MC can raise USD (oan at =/= 4 Euro (oan at9/1

• ot$ want eui*a(ent o& USD 2.. ! %#e' rate%nancin &or 1. years

• Current EUR6USD spot rate: EUR 1/1@USD 22


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CS: E/ A'apte' &ro! A(an S$apiro

BorrowingParty

USD Rate Euro Rate

DC US =/5 9/25

MC 0r/ =/= 9/1

Dierence 2. "ps 15 "ps

2-


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0i#e'6&or60i#e' CS: E/ &ro! S$apiro

• Current EUR6USD spot rate: EUR 1/1@USD

• ot$ cos/ want USD 2..! eu/ o& %nancin

• It is c$eaper &or DC to "orrow in USD 4 &orMC to "orrow EUR

• Eac$ co/ 'esires t$at &or! o& (oan t$at is!ore e#pensi*e &or it

• So DC s$ou(' "orrow in USD 4 MC s$ou('

"orrow in EUR 4 t$en t$ey s$ou(' swap• DC s$ou(' "orrow USD 2..! at =/5 4 MC

s$ou(' "orrow 2..1/1 EUR 22.! at 9/1

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0i#e'6&or60i#e' CS: E/ A'apte' &ro! S$apiro

ene%t o& t$is swap wou(' "e t$at:• DC wou(' "e eecti*e(y

"orrowin in EUR J 9/1 instea'

o& 9/25 t$at is app(ica"(e to it• MC wou(' "e eecti*e(y

"orrowin in USD J =/5 instea'o& =/= t$at is app(ica"(e to it

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0i ' & 0( ti CS E


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0i#e'6&or60(oatin CS: E/&ro! A(an S$apiro

BorrowingParty

USD Rate Euro Rate(Floating)

DC US =/5 LIOR <./-5

MC 0r/ =/= LIOR


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0i#e'6&or60(oatin CS: E/ &ro! S$apiro

• Current EUR6USD spot rate: EUR 1/1@USD

• ot$ cos/ want USD 2..! eu/ o& %nancin

• It is c$eaper &or DC to "orrow in USD 4 &orMC to "orrow EUR

• Eac$ co/ reuires t$at &or! o& (oan t$at is!ore e#pensi*e &or it

• So DC s$ou(' "orrow in USD 4 MC s$ou('

"orrow in EUR 4 t$en t$ey s$ou(' swap• DC s$ou(' "orrow USD 2..! at =/5 4 MC

s$ou(' "orrow 2..1/1 EUR 22.! at

LIOR < ./125 2=


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0i#e'6&or60(oatin CS: E/ A'apte' &ro! S$apiro

• In practice a co!!ercia( "an7 @in*est!ent "an7 wou(' "e inter!e'iary

• ,$e inter!e'iary wou(' c$are a &ee

• Inter!e'iary cou(' "e eit$er a "ro7er or a'ea(er

• I& it acts as a "ro7er it wou(' Hust arranet$e transaction

• I& it acts as a 'ea(er it wou(' a(souarantee swap pay!ents to "ot$ parties

• Dea(er !ust $a*e a $i$ cre'it ratin29

& S


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Reasons &or Swaps

• Cre'it sprea' 'ierentia(: Dierencese#istin in %nancia( !ar7etsG in t$eperception o& co!pare' cre'it ua(ity"etween %r!s wit$ 'ierent cre'it

ratins

• Mar7et saturation: A speci%c !ar7et"eco!es saturate' wit$ paper &ro! one

particu(ar issuer on(y• Dierent %nancia( nor!s: Dierent

countries !ay $a*e 'ierent nor!s o&

accepta"(e para!eters o& cre'it 2

MOD5-SWAPS.pptx

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