Assignment

Name: Akanksha
Roll no.: 1202
Subject: Commodity Trading Futures and Options

• Advantages of Swap agreement over a back- to- back loan:

1. Swap agreement is less time consuming as compared back-to-back loan.
2. Back-to-back are on balance-sheet transactions whereas swaps are considered off-
balance sheet.
3. A back-to-back loan results in two legally separate loans while a swap can embody
the right-of-offset if one counterparty defaults.
• Fixed –Floating interest rate swap and advantages of swap agreement compared to
future contracts:
In fixed- floating interest rate swap, one party swaps the interest cash flows of
fixedrate loans with those of floating-rate loans held by another party. The counterparty
pays a floating rate at regular intervals over a period of years. The swap represents a set
of forward contracts, with maturities of 6 months, 12 months etc. The cash flows can be
replicated with a set of interest rate future contracts.
Swap agreement lowers the transaction costs. It makes the responsibilities of
counterparties explicit and extends the maturity of market beyond the normal maturity
of interest rate futures contracts.
• Role of a swap Dealer:
1. A swap dealer is an individual that deals in swaps and makes market in swap or
enters swaps with counterparties.
2. A swap dealer pays a similar role as a foreign exchange or government bond dealer.
3. The Swap dealer is usually a bank employee, financial institution, or a subsidiary of
one of these companies.
4. Swap dealer plays an intermediary role between retail customers.
5. The swap dealers also trade on an interbank basis with other swap dealers. Interbank
trading helps to establish market liquidity and market prices for various categories of
swaps.
• Counterparty Risk and Market Risk in Swap agreement:
Counterparty risk includes the risk of default by one of the counterparties to a swap
transaction. Holder of the fixed rate seeks to avoid this risk because if the holder of
floating rate is unable to make payments under the swap agreement, the holder of the
fixed rate has credit exposure to changes in the interest rate agreement.
Market Risk in a swap is the risk that the replacement cost of a swap will be higher than
its initial cost if the counterparty has defaulted.
• “A floating rate payer in a fixed floating interest rate swap can be viewed as short
the bond market” True OR False:
This is a false statement. A floating-rate payer receives fixed-rate interest. If the
interest rates increase and bond prices fall, the floating-rate payer feels a loss from his
higher interest expenses. A speculator with a long position in the bond market also
suffers a loss when interest rates increase.