Swaps

Nature of Swaps
A swap is an agreement to exchange cash flows at specified future times according to certain specified rules

Types of swaps
Interest

rate swaps Currency swaps

Interest rate swaps

It

is a contractual agreement between counter-parties to exchange a series of interest payments for a stated period of time. There is no exchange of principal Only the net value of interest payment is exchanged. Company borrowing fixed when it wants floating or borrowing floating when it wants fixed.

Typical Uses of an Interest Rate Swap

Converting

fixed rate to floating rate floating rate to fixed rate

a liability from

Converting

fixed rate to floating rate floating rate to fixed rate

an investment from

Currency swap
It

is a contractual agreement between counterparties in which one party makes payments in one currency and the other party makes payment in a different currency for a stated period of time. There may be a exchange of principal.

Typical Uses of a Currency Swap

Conversion

from a liability in one currency to a liability in another currency from an investment in one currency to an investment in another currency

Conversion

Example
If

a U.S. company is looking to acquire some yen, and a Japanese company is looking to acquire U.S. dollars, these two companies could perform a swap. The Japanese company likely has better access to Japanese debt markets and could get more favorable terms on a yen loan than if the U.S. company went in directly to the Japanese debt market itself, and vice versa in the U.S. for the Japanese company.
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Terminology
Counter

parties Swap dealer Effective/value date Reference rate Notional principal

Structure of swaps
The

swap commences on its effective date and terminates on its maturity date. The swap payments will be made at periodic intervals. The swap arrangement involves a financial intermediary a swap dealer or market maker or even a swap bank. The swap dealer profits from the pay receive or bid spread offer.