Swap market Exercises - Quản lý tài chính | Trường Đại học Hà Nội

lOMoARcPSD|44744371 lOMoARcPSD|44744371 Chapter Ten Currency & Interest Rate Swaps INTERNATIONAL 10 FINANCIAL MANAGEMENT Chapter Objective:
This chapter discusses currency and interest rate
swaps, which are relatively new instruments for
hedging long-term interest rate risk and foreign exchange risk. EUN / RESNICK Second Edition lOMoARcPSD|44744371 Chapter Outline  Types of Swaps
 Size of the Swap Market  The Swap Bank  Interest Rate Swaps  Currency Swaps lOMoARcPSD|44744371 Chapter Outline (continued)
 Swap Market Quotations
 Variations of Basic Currency and Interest Rate Swaps
 Risks of Interest Rate and Currency Swaps
 Swap Market Efficiency
 Concluding Points About Swaps
McGraw-Hill/Irwin
.com)-Hill Companies, Inc. All rights lOMoARcPSD|44744371 Definitions
 In a swap, two counterparties agree to a
contractual arrangement wherein they agree
to exchange cash flows at periodic intervals.
 There are two types of interest rate swaps:
 Single currency interest rate swap
 “Plain vanilla” fixed-for-floating swaps are often just
called interest rate swaps.
 Cross-Currency interest rate swap
 This is often called a currency swap; fixed for fixed rate
debt service in two (or more) currencies. lOMoARcPSD|44744371 Size of the Swap Market
 In 1995 the notational principal of:
interest rate swaps was $12,810,736,000,000.
Currency swaps $1,197,395,000,000
 The most popular currencies are:  U.S.$ (34%)  ¥ (23%)  DM (11%)  FF (10%)  £ (6%)
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10-4.com)-Hill Companies, Inc. All rights lOMoARcPSD|44744371 The Swap Bank
 A swap bank is a generic term to describe a
financial institution that facilitates swaps between counterparties.
 The swap bank can serve as either a broker or a dealer.
 As a broker, the swap bank matches counterparties
but does not assume any of the risks of the swap.
 As a dealer, the swap bank stands ready to accept either
side of a currency swap, and then later lay off their
risk, or match it with a counterparty.
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An Example of an Interest Rate Swap
 Consider this example of a “plain vanilla” interest rate swap.
 Bank A is a AAA-rated international bank located
in the U.K. who wishes to raise $10,000,000 to
finance floating-rate Eurodollar loans.
 Bank A is considering issuing 5-year fixed-
rate Eurodollar bonds at 10 percent.
 It would make more sense to for the bank to issue
floating-rate notes at LIBOR to finance floating- rate Eurodollar loans.
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An Example of an Interest Rate Swap
 Firm B is a BBB-rated U.S. company. It needs
$10,000,000 to finance an investment with a five- year economic life.
 Firm B is considering issuing 5-year fixed-
rate Eurodollar bonds at 11.75 percent.
 Alternatively, firm B can raise the money by issuing
5-year FRNs at LIBOR + ½ percent.
 Firm B would prefer to borrow at a fixed rate.
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An Example of an Interest Rate Swap
The borrowing opportunities of the two firms are shown in the following table:
COMPANY B BANK A DIFFERENTIAL Fixed rate 11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% QSD = 1.25%
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An Example of an Interest Rate Swap Swap The swap bank makes this offer to Bank A: Bank 10 3/8% You pay LIBOR – 1/8 % per year on $10 million LIBOR – 1/8% for 5 years and we will Bank pay you 10 3/8% on $10 A million for 5 years COMPANY B BANK DIFFERENTIAL A Fixed rate 11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% QSD = 1.25%
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An Example of an Interest Rate Swap ½ % of $10,000,000 = Swap
Here’s what’s in it for Bank A: $50,000. That’s quite a They can borrow externally at cost savings per year for 5 Bank 10% fixed and have a net years. 10 3/8% borrowing position of LIBOR – 1/8%
-10 3/8 + 10 + (LIBOR – 1/8) = Bank 10% LIBOR – ½ % which is ½ % A better than they can borrow floating without a swap. COMPANY B BANK A DIFFERENTIAL Fixed rate 11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% Q
SD = 1.25%
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An Example of an Interest Rate Swap The swap bank makes this Swap offer to company B: You Bank pay us 10 ½ % per year on 10 ½% $10 million for 5 years LIBOR – ¼% and we will pay you LIBOR – ¼ % per year on Company $10 million for 5 years. B COMPANY B BANK A DIFFERENTIAL Fixed rate 11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% QSD = 1.25%
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An Example of an Interest Rate Swap ½ % of $10,000,000 =
Here’s what’s in it for B: Swap $50,000 that’s quite a cost Bank savings per year for 5 10 ½% years.
They can borrow externally at LIBOR + ½ % LIBOR – ¼% and have a net borrowing position of Company
10½ + (LIBOR + ½ ) - (LIBOR - ¼ ) = 11.25% LIBOR
which is ½ % better than they can borrow B + ½% floating without a swap. COMPANY B BANK A DIFFERENTIAL Fixed rate 11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% Q
SD = 1.25%
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An Example of an Interest Rate Swap The swap bank Swap ¼ % of $10 million makes money too. = $25,000 per year Bank 10 3/8 % 10 ½% for 5 years. LIBOR – ¼% LIBOR – 1/8% Bank 10%
LIBOR – 1/8 – [LIBOR – ¼ ]= 1/8 Company LIBOR + ½% A 10½-103/8=1/8 B A saves ½ % ¼ B saves ½ % COMPANY B BANK A DIFFERENTIAL Fixed rate 11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% QSD = 1.25%
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An Example of an Interest Rate Swap The swap bank Swap makes ¼ % Bank 10 3/8 % 10 ½% LIBOR – ¼% LIBOR – 1/8% 10% Bank Company LIBOR
Note that the total savings + ½% A ½+½+¼=1.25%=QSD B A saves ½ % B saves ½ % COMPANY B BANK A DIFFERENTIAL Fixed rate 11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% Q
SD = 1.25%
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, Inc. All rights lOMoARcPSD|44744371 The QSD
 The Quality Spread Differential represents the
potential gains from the swap that can be shared
between the counterparties and the swap bank.
 There is no reason to presume that the gains will be shared equally.
 In the above example, company B is less credit-
worthy than bank A, so they probably would have
gotten less of the QSD, in order to compensate
the swap bank for the default risk.
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, Inc. All rights lOMoARcPSD|44744371 An Example of a Currency Swap
 Suppose a U.S. MNC wants to finance a
£10,000,000 expansion of a British plant.
 They could borrow dollars in the U.S. where
they are well known and exchange for dollars for pounds.
 This will give them exchange rate risk: financing
a sterling project with dollars.
 They could borrow pounds in the international
bond market, but pay a lot since they are not as well known abroad.
McGraw-Hill/Irwin All rights lOMoARcPSD|44744371 An Example of a Currency Swap
 If they can find a British MNC with a mirror-
image financing need they may both benefit from a swap.
 If the exchange rate is S0($/£) = $1.60/£, the
U.S. firm needs to find a British firm wanting to
finance dollar borrowing in the amount of $16,000,000.
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