CURRENCY SWAP
INDIA(INR) - JAPAN(YEN)
AMIT RAJ - Roll no. 08 (9833468882)
KRIPAMURTI – Roll no. 28 (9916197069)
PRIYANKA K - Roll no. 40 (7259520213)
SANDEEP KUMAR - Roll no. 48 (9886330990)
SHAKTI SOBHAN PANDA - Roll no. 50 (9611230016)
What is Currency Swap
• In financial market, swaps are use to arrange
complex and innovation financings that reduces the
borrowing cost on loan and gives a better control
over high interest rate risk and foreign currency
exposure.
• The currency swap is also known as Cross-Currency
Swap, as most often it is used when companies make
cross-border capital investments.
• Currency Swap is an agreement between two parties
or countries in which they exchange the principal
amount of a loan and the interest in one currency
for the principle and interest in another currency for
a period of time.
Unlike the interest rate swap where
parties exchange only the interest rate
from floating rate to fixed rate & vice-
versa, here parties exchange both
notional value (principal value) &
interest rate.
Origins of currency swaps
Currency swaps was conceived by UK banks in 1970 to help their big clients to avoid
paying premium while obtaining dollar loans from their banks. These swap
agreements were called back-to-back loans or parallel loans .
Original currency swap agreement were laid out as:
• The UK organization borrowed sterling and lent it to the US company’s UK
subsidiary.
• The US organization borrowed dollars and lent it to the UK company’s US
subsidiary.
Ways of basic Currency Swap:
During the mentioned / agreed time period of contract, currency swap can be done in
different ways. Interest rate can be exchanged in 4 different ways:
• Fixed for Fixed
• Fixed for Floating
• Floating for Fixed
• Floating for Floating.
A Currency Swap is a "off-balance sheet" transactions, and is considered a foreign
exchange transaction. There is no legally required to be shown on a company's balance
sheet or disclosed in their financial statements
Why Countries Swap Currency
The main intentions of parties to entering a currency swap are:
• Support to strengthen currencies
• reduce risk of losses in deals where various currencies involved.
• helps in regulate exposure to interest rates.
• benefit from a favorable change in interest rates.
• Reduce costs and risks associated with currency exchange.
• Companies having fixed rate liabilities can capitalize on floating-rate swaps
and vise versa, based on the prevailing economic scenario.
Currency Swap & similar kind of other deals are motivated by comparative advantage.
Important elements of Currency Swap:
Initial Exchange of principal: In the initial exchange, decisions on the mode of coupon
payments method are made. It can be fixed vs fixed, fixed vs floating, floating vs
floating and is usually driven by the demand of international funds flow. They have
significant settlement risk exposure from the high value of the initial and final principal
exchange.
Interest payment: the value of currency is derived from spot rate and forward interest
rates. If the firm thought that the price would rise or fall, it would enter into a swap
agreement and pay fixed to receive floating, or floating to receive fixed, in order to
protect it from rising debt service payments or to take advantage of lower debt service
payments respectively. Here no principal is swapped only the coupon payments.
Interest rates are interrelated to foreign exchange forward rates and foreign exchange
spot rates by interest rate parity(IRP) principle.
The Final Exchange of principal: The total return of assets in periodic cash flow
includes floating or fixed rates such as LIBOR rates. Since most swaps are executed on
large notional amounts, this could put the payer at a risk of hedge fund’s default if the
fund is not sufficiently capitalized.
Who works on Currency Swap
Recently Indian government formed eleven membered task force to work on
currency swap agreements. The task force consists of members from:
• Commerce Ministry
• Department of economic affaires and financial services
• Reserve Bank of India(RBI)
• State bank of India(SBI)
• Confederation of Indian industry(CII)
• Federation of Indian chamber of commerce and industry (FICCI)
• Exporters body Federation of Indian Chambers of Commerce and
Industry (FIEO).
Example of Currency Swap:
• Company A of USA wants to set up a factory in Mumbai, India. For that purpose
Company A needs a loan of 70 lakhs in India currency for 5 years.
• Another company B in India wants to setup a subsidiary in USA, for which it needs a
loan of 1million USD for 5 years.
o assume, spot rate : 1$ (USD) = Rs.70
Therefore, both of them need equal amount of money.
• Company A is getting loan in homeland i.e. USA at 5% where it is getting loan in
India at 11%
• Company B is getting loan in homeland i.e. India at 10% where it is getting loan in
USA at 6%.
So,
• Company A has an advantage in USD but it needs INR loan.
• On the contrary, Company B an advantage in INR but it needs USD loan.
Cont..
Example of Currency Swap:
• Company A borrows INR, it has to pay 11%, which is 1% more than what company B
will pay for borrowing INR.
• Similarly, Company B borrows USD, it has to pay 6%, which is 1% more than
company A’s borrowing cost of USD.
As per the requirement and the prevailing exchange rate, both the companies need
equal amount of money for an equal period. Therefore they can do currency swap.
To get the benefit of low exchange rate, both companies can do a currency swap.
• Suppose, Company A borrows 1 million USD for 5years at the rate of 5% and passes
this to Company B
• Company B on contrary, borrows INR 70 Lakhs for 5years at the rate of 10% and
passes this to Company A
Cont..
Example of Currency Swap:
• For a period of 5 years, Company A will pay 10% on 70Lakhs, i.e. 7Lakhs to
Company B and at the end of 5years A will Pay B the principal amount of 70Lakhs.
• Similarly, Company B will pay 5% on $1Million, i.e. $0.05Million to Company B and
at the end of 5years B will Pay A the principal amount of $1Million.
THE LATEST
INDO-
JAPANESE
CURRENCY
SWAP
AGREEMENT -
OCTOBER 2018
Details of the Currency Swap Agreement:
• Valued at $75 billion
• 50% higher than India’s previous currency swap agreement with Japan
• Negotiated by Prime Minister Narendra Modi for India and his Japanese counterpart
Shinzo Abe
• Agreement will allow the Reserve Bank of India to draw up to $75 billion worth of yen
or dollars as a loan from the Japanese government whenever that money is required, in
exchange for Rupees
• India to pay interest on the loan at Libor (London Inter-bank rate)
• Largest bilateral currency swap arrangement among the various deals that India has
with many Asian nations
• Japan holds the second largest dollar reserves (of over $1,250 billion) after China
Details of the Currency Swap Agreement:
• India hopes this deal to act as a buffer to boost up the Rupee, which saw a
depreciation of nearly 14% against the US Dollar in 2018
• If Japan’s Central Bank were to reach out to India for a $75-billion loan, then
India also must oblige to provide Japanese loan the from its reserves at Libor, in
exchange for Yen; but the likelihood of this happening is very low
• This deal comes at a time when there has been a steady rise in interest rates in the
US resulting in the strengthening of the US dollar against several world currencies
Why is this Agreement Important to India?
• To bolster the Rupee - must be seen in the context of Rupee depreciation as a result of
India’s widening Current Account Deficit (CAD) resulting in higher demand for
dollars from Importers compared to what exporters bring to India
• Currently (as of January 2019), India has a comfortable forex reserve of about $396
billion and this loan will give them an additional buffer in case a bad situation arises;
India won’t have to approach the International Monetary Fund (IMF) for a loan
Why is this Agreement Important to India?
• Because this is a currency swap agreement, India has the benefit of availing this loan at
really low interest rates
• This agreement will also aid in bringing greater stability to capital markets in India
• Rise in India’s creditworthiness and improved confidence in the Indian market
How Can RBI Use This Money?
• To be used only when required; will help India
meet short-term liquidity mismatches
• Sell the borrowed dollars (or yen) to importers to
settle their bills
• Sell it to borrowers to pay off their foreign loans -
external financing
• Hold on to the money to support its own forex
reserves and back up the rupee
How will Japan Benefit from the Agreement?
• While Japan may not need a loan from India due to its own huge dollar reserves, this
agreement will boost their relations with India from an investment point of view
• India accepted Japan’s request to do away with requirement of obligatory hedging
for infrastructure ECBs (External Commercial Borrowings) of 5 years or more
minimum average maturity
• This also supports Japan’s and China’s outlook to end the domination of the US
Dollar, with a big nation like India using their currency to settle its bills
Sources
• [Link]
wanted-to-know-aboutep/[Link]
• [Link]
billion-currency-swap-agreement/articleshow/[Link]
• [Link]
in-75-billion-currency-swap-pact-in-japan/articleshow/[Link]
• [Link]
usd-75-billion-currency-swap-agreement/story/[Link]
• [Link]
swap-pact-with-japan-to-stabilise-rupee
• [Link]
currency-swap-agreement-between-india-and-japan-work-
118103001296_1.html
• [Link]
sign-75-billion-currency-swap-agreement-idUSKCN1N31BS
