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1、INTERNATIONALFINANCIALMANAGEMENTEUN/RESNICKSecond Edition10Chapter TenCurrency&Interest Rate SwapsChapter 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.Chapter OutlinelTypes of
2、 SwapslSize of the Swap MarketlThe Swap BanklInterest Rate SwapslCurrency Swaps1Chapter Outline(continued)lSwap Market QuotationslVariations of Basic Currency and Interest Rate SwapslRisks of Interest Rate and Currency SwapslSwap Market EfficiencylConcluding Points About Swaps2DefinitionslIn a swap,
3、two counterparties agree to a contractual arrangement wherein they agree to exchange cash flows at periodic intervals.lThere are two types of interest rate swaps:nSingle currency interest rate swapu“Plain vanilla”fixed-for-floating swaps are often just called interest rate swaps.nCross-Currency inte
4、rest rate swapuThis is often called a currency swap;fixed for fixed rate debt service in two(or more)currencies.3Size of the Swap MarketlIn 1995 the notational principal of:interest rate swaps was$12,810,736,000,000.Currency swaps$1,197,395,000,000lThe most popular currencies are:nU.S.$(34%)n(23%)nD
5、M(11%)nFF(10%)n(6%)4The Swap BanklA swap bank is a generic term to describe a financial institution that facilitates swaps between counterparties.lThe swap bank can serve as either a broker or a dealer.nAs a broker,the swap bank matches counterparties but does not assume any of the risks of the swap
6、.nAs 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.5An Example of an Interest Rate SwaplConsider this example of a“plain vanilla”interest rate swap.lBank A is a AAA-rated international bank located in th
7、e U.K.who wishes to raise$10,000,000 to finance floating-rate Eurodollar loans.nBank A is considering issuing 5-year fixed-rate Eurodollar bonds at 10 percent.nIt would make more sense to for the bank to issue floating-rate notes at LIBOR to finance floating-rate Eurodollar loans.6An Example of an I
8、nterest Rate SwaplFirm B is a BBB-rated U.S.company.It needs$10,000,000 to finance an investment with a five-year economic life.nFirm B is considering issuing 5-year fixed-rate Eurodollar bonds at 11.75 percent.nAlternatively,firm B can raise the money by issuing 5-year FRNs at LIBOR+percent.nFirm B
9、 would prefer to borrow at a fixed rate.7An Example of an Interest Rate SwapThe borrowing opportunities of the two firms are shown in the following table:810 3/8%LIBOR 1/8%An Example of an Interest Rate SwapBank ASwap BankThe swap bank makes this offer to Bank A:You pay LIBOR 1/8%per year on$10 mill
10、ion for 5 years and we will pay you 10 3/8%on$10 million for 5 years 910 3/8%LIBOR 1/8%An Example of an Interest Rate SwapBank ASwap BankHeres whats in it for Bank A:They can borrow externally at 10%fixed and have a net borrowing position of-10 3/8+10+(LIBOR 1/8)=LIBOR%which is%better than they can
11、borrow floating without a swap.10%of$10,000,000=$50,000.Thats quite a cost savings per year for 5 years.10LIBOR%10%An Example of an Interest Rate SwapSwap BankCompany BThe swap bank makes this offer to company B:You pay us 10%per year on$10 million for 5 years and we will pay you LIBOR%per year on$1
12、0 million for 5 years.11LIBOR%10%An Example of an Interest Rate SwapSwap BankCompany BThey can borrow externally at LIBOR+%and have a net borrowing position of 10 +(LIBOR+)-(LIBOR-)=11.25%which is%better than they can borrow floating without a swap.LIBOR+%Heres whats in it for B:%of$10,000,000=$50,0
13、00 thats quite a cost savings per year for 5 years.12LIBOR+%10 3/8%LIBOR 1/8%LIBOR%10%B saves%An Example of an Interest Rate SwapBank ASwap BankCompany BA saves%The swap bank makes money too.10%of$10 million=$25,000 per year for 5 years.LIBOR 1/8 LIBOR =1/8 10 -10 3/8=1/8 13LIBOR+%10 3/8%LIBOR 1/8%L
14、IBOR%10%B saves%An Example of an Interest Rate SwapBank ASwap BankCompany BA saves%The swap bank makes%10%Note that the total savings +=1.25%=QSD14The QSDlThe Quality Spread Differential represents the potential gains from the swap that can be shared between the counterparties and the swap bank.lThe
15、re is no reason to presume that the gains will be shared equally.lIn the above example,company B is less credit-worthy than bank A,so they probably would have gotten less of the QSD,in order to compensate the swap bank for the default risk.15An Example of a Currency SwaplSuppose a U.S.MNC wants to f
16、inance a 10,000,000 expansion of a British plant.lThey could borrow dollars in the U.S.where they are well known and exchange for dollars for pounds.nThis will give them exchange rate risk:financing a sterling project with dollars.lThey could borrow pounds in the international bond market,but pay a
17、lot since they are not as well known abroad.16An Example of a Currency SwaplIf they can find a British MNC with a mirror-image financing need they may both benefit from a swap.lIf the exchange rate is S0($/)=$1.60/,the U.S.firm needs to find a British firm wanting to finance dollar borrowing in the
18、amount of$16,000,000.17An Example of a Currency SwapConsider two firms A and B:firm A is a U.S.based multinational and firm B is a U.K.based multinational.Both firms wish to finance a project in each others country of the same size.Their borrowing opportunities are given in the table below.18An Exam
19、ple of a Currency SwapCompany ASwap Bank$8%12%$8%11%12%$9.4%Company B19An Example of a Currency SwapCompany ASwap Bank$8%12%$8%11%12%$9.4%Company BAs net position is to borrow at 11%A saves.6%20An Example of a Currency SwapCompany ASwap Bank$8%12%$8%11%12%$9.4%Company BBs net position is to borrow a
20、t$9.4%B saves$.6%21An Example of a Currency SwapCompany ASwap Bank$8%12%$8%11%12%$9.4%Company BThe swap bank makes money too:At S0($/)=$1.60/,that is a gain of$124,000 per year for 5 years.The swap bank faces exchange rate risk,but maybe they can lay it off in another swap.1.4%of$16 million financed
21、 with 1%of 10 million per year for 5 years.22A is the more credit-worthy of the two firms.Comparative Advantage as the Basis for SwapsA has a comparative advantage in borrowing in dollars.B has a comparative advantage in borrowing in pounds.A pays 2%less to borrow in dollars than BA pays.4%less to b
22、orrow in pounds than B:23B has a comparative advantage in borrowing in.Comparative Advantage as the Basis for SwapsB pays 2%more to borrow in dollars than AB pays only.4%more to borrow in pounds than A:24A has a comparative advantage in borrowing in dollars.B has a comparative advantage in borrowing
23、 in pounds.If they borrow according to their comparative advantage and then swap,there will be gains for both parties.Comparative Advantage as the Basis for Swaps25Swap Market QuotationslSwap banks will tailor the terms of interest rate and currency swaps to customers needslThey also make a market i
24、n“plain vanilla”swaps and provide quotes for these.Since the swap banks are dealers for these swaps,there is a bid-ask spread.lFor example,6.60 6.85 means the swap bank will pay fixed-rate DM payments at 6.60%against receiving dollar LIBOR or it will receive fixed-rate DM payments at 6.85%against re
25、ceiving dollar LIBOR.26Variations of Basic Currency and Interest Rate SwapslCurrency Swapsnfixed for fixed nfixed for floatingnfloating for floatingnamortizinglInterest Rate Swaps nzero-for floatingnfloating for floatinglFor a swap to be possible,a QSD must exist.Beyond that,creativity is the only l
26、imit.27Risks of Interest Rate and Currency SwapslInterest Rate RisknInterest rates might move against the swap bank after it has only gotten half of a swap on the books,or if it has an unhedged position.lBasis RisknIf the floating rates of the two counterparties are not pegged to the same index.lExc
27、hange rate RisknIn the example of a currency swap given earlier,the swap bank would be worse off if the pound appreciated.28Risks of Interest Rate and Currency Swaps(continued)lCredit RisknThis is the major risk faced by a swap dealerthe risk that a counter party will default on its end of the swap.
28、lMismatch RisknIts hard to find a counterparty that wants to borrow the right amount of money for the right amount of time.lSovereign RisknThe risk that a country will impose exchange rate restrictions that will interfere with performance on the swap.29Pricing a SwaplA swap is a derivative security
29、so it can be priced in terms of the underlying assets:lHow to:nPlain vanilla fixed for floating swap gets valued just like a bond.nCurrency swap gets valued just like a nest of currency futures.30Swap Market EfficiencylSwaps offer market completeness and that has accounted for their existence and gr
30、owth.lSwaps assist in tailoring financing to the type desired by a particular borrower.Since not all types of debt instruments are available to all types of borrowers,both counterparties can benefit(as well as the swap dealer)through financing that is more suitable for their asset maturity structures.31Concluding RemarkslThe growth of the swap market has been astounding.lSwaps are off-the-books transactions.lSwaps have become an important source of revenue and risk for banks32End Chapter Ten33