Interest Rate

Swaps
And
Currency Swaps
Meaning of Financial
Swaps
A swap is an contractual agreement to
exchange cash flows at specified future times
according to certain specified rules (between
two parties)




Interest Rate And Currency Swaps 2

Background
Swaps first evolved in 1981, in the form of
currency swaps, (IBM and the World Bank for
$210 million dollars and a term of over ten
years)

Interest rate swaps emerged, which offered an
alternative method to overcome asset-liability
mismatches and to lower the cost of
borrowing.

Swaps provide a level playing field for risk
management but still struggle to find a
future, especially inCurrency
Interest Rate And developing
Swaps countries like 3
Types of swaps

Interest Rate Swaps

Currency Swaps

Commodity Swaps

Equity Swaps

Interest Rate And Currency Swaps 4

Interest Rate And Currency Swaps 5
Interest rate swaps
An interest rate swap is defined as a mutual
agreement among different parties, to
exchange interest payments over a
predetermined period.

The primary motives behind the interest rate
swaps are to lower the costs of borrowing and
to overcome the asset liability mismatch.


Interest Rate And Currency Swaps 6

Uses of an Interest
Rate Swap
Converting a Converting an
liability from investment from
fixed rate to fixed rate to
floating floating rate
rate floating rate
floating rate to fixed rate
to fixed
rate
Types of Interest
Swaps

Plain Vanilla Swaps
Off Market Swaps
Index Amortization Swaps
Floating – Floating Swaps
Forward Swaps
Callable Swaps
Putable Swaps


Interest Rate And Currency Swaps 8

Fixed to Floating
Also known as Plain Vanilla swap

customer receives cash flows at a fixed rate of
interest and simultaneously pays cash flows
at a floating rate of interest or vice versa. The
cash flows are calculated on a Notional
Principal amount. The floating rate of interest
is usually determined by reference to a
transparent benchmark

Interest Rate And Currency Swaps 9

An Example of a Plain Vanilla
Fixed-for-Floating Interest
Party A- (Receives Floating Rate) Party B- (Pays the Floating Rate)



Notional Principal- $40 million.

Fixed rate day count method is 30/360 day basis.
Floating rate is Six- Month LIBOR, determined on a 30/360 day basis.

Swaps origination: July 20, 1999.
Swaps termination: July 20, 2000.
First payment: January 20, 2000
Semiannual payments will be made on each July 20 and January 20.

 


7% fixed rate

A


B


 6 month LIBOR

Interest Rate And Currency Swaps 11

Valuation Of Plain
Vanilla Swap
The present value of a plain vanilla swap can easily
be computed using standard methods of
determining the present value (PV) of the fixed
leg and the floating leg.


value of the fixed leg:

where; C is the swap rate,
M is the number of fixed payments,

P is the notional amount,

t is the number of days in period i,

i
T is the basis according to the day count convention
i
df is the discount factor.
i
Interest Rate And Currency Swaps 12
value of the floating leg:

Where, N is the number of floating payments,
f is the forward rate,
j
P is the notional amount,
t is the number of days in period j,
j
Tj is the basis according to the day count
convention
df is the discount factor.
j


Interest Rate And Currency Swaps 13

Floating to Floating
In this kind of a swap, both the counter-parties
exchange interest amounts based on two
different floating reference rates, through the
life of the swap.


Interest Rate And Currency Swaps 14

Index Amortization
Swap
A swap whereby the notional principal amount
of the agreement is amortized according to
the movement of an underlying rate.

Interest Rate And Currency Swaps 15

Forward Swaps
A swap agreement created through the
synthesis of two swaps differing in duration
for the purpose of fulfilling the specific time-
frame needs of an investor. Also referred to
as a "forward start swap," "delayed start
swap," and a "deferred start swap."

Interest Rate And Currency Swaps 16

Off market Swap
An interest rate or other swap contract with a
fixed rate payment materially different from
current coupon rates on bonds or notes of
similar term. Ordinarily, this swap will have a
net present value that requires the
counterparties to exchange an extra payment
at the beginning or end of the swap tenor.
Also called Adjustment Swap

Interest Rate And Currency Swaps 17

Callable Swaps & Putable
Swaps
Fixed rate receiver has the right, but not the
obligation to terminate the swap at one or
more pre-determined times during the life of
the swap.
A Swap where the fixed rate payer has the
right to terminate is known as a Callable
Swap. Both the Putable and Callable Swaps
are also known as Cancellable Swaps.
The foreign exchange version of a Cancellable
Swap is called the Break Forward or
Cancellable Forward.
Interest Rate And Currency Swaps 18
Limitations of Swap
Deals
Counter Party Risk

Fund Requirement

Cordial Relationships

Information Network

Interest Rate And Currency Swaps 19

Currency swaps
Foreign currency swaps involve the exchange
of the principal at the beginning of the
contract and the re-exchange of the principal
at the end of the contract.
A Currency Swap involves exchange of
principal and/or interest payments on a loan
or on an asset in one currency for principal
and/or interest payments on an equivalent
loan or on an asset in another currency, with
a predetermined prevailing spot /
predetermined forward rate (for forward start
swaps) as Interest
agreed on the date the transaction20
Rate And Currency Swaps
In an interest rate swap the principal is not
exchanged

In a currency swap the principal is exchanged
at the beginning and the end of the swap


Interest Rate And Currency Swaps 21

Uses of a Currency
Swap
Conversion from a Conversion from an
liability in one investment in one
currency to a liability currency to an
in another currency investment in
another currency

Types of currency
swaps
Fixed for fixed


Fixed for floating


Floating for fixed

Floating for floating

Interest Rate And Currency Swaps 23

 F ix e d - fo r- F ix e d
C u rre n cy S w a p
E x a m p le

Initial Cash Flow ( Exchange of Principal )

DM Lender US$ Lender

DM 25 million
DM 25 mil Party C Party D
US$ 10 mil
$10 million

24
 Periodic Annual Interest Payments

DM Lender US$ Lender

US$ 1 million
Party C Party D
DM 2 mil US$ 1 mil
DM 2 million

inal Cash Flow ( Repayment of Principal )

DM Lender DM 25 million US$ Lender

DM 25 mil US$ 10 mil

Party C $10 million Party D

Interest Rate And Currency Swaps 25

Fixed-for-Floating
Currency Swap
Example
Principal 1: ¥2080million and rate of interest is
1%
Principal 2: $20 million @ six month LIBOR
Settlement date is every 6 month

Swaps origination: July 20, 1999.
Swaps termination: July 20, 2000.


Interest Rate And Currency Swaps 26



• ¥ 2080Mn. @ 1% fixed

A B
int.
•
•
• $ 20 Mn.@ 6m
LIBOR

Interest Rate And Currency Swaps 27

Valuation of Currency
Swaps
Like interest rate swaps, currency swaps can
be valued either as the difference between 2
bonds or as a portfolio of forward contracts.


Interest Rate And Currency Swaps 28

Thank You …

Interest Rate And Currency Swaps 29