Risk MGMT Mod 3.

RISK MANAGEMENT USING
SWAPS
THE TERM SWAP MEANS TO BARTER OR TO
GIVE IN EXCHANGE OR TO EXCHANGE ONE
FOR ANOTHER.SO SWAPS ARE PRIVATE
AGREEMENTS BETWEEN THE TWO PARTIES
TO EXCHANGE CASH FLOWS IN THE FUTURE
ACCORDING TO A PREARRANGED FORMULA.
SO SWAPS IS AN AGREEMENT TO EXCHANGE
PAYMENTS OF TWO DIFFERENT KINDS IN
THE FUTURE.
7/11/2013 Prof. D. Gopinath 1
RISK MANAGEMENT USING SWAPS
IN THE CONTEXT OF FINANCIAL MARKETS
THE TERM SWAP HAS TWO MEANING:-
1. IT IS A PURCHASE AND SIMULTANEOUS
FORWARD SALE OR VICE VERSA.
2. IT IS DEFINED AS THE AGREED EXCHA-
NGE OF FUTURE CASH FLOWS POSSIBI-
LY BUT NOT NECESSARILY WITH A
SPOT EXCHANGE OF CASH FLOWS.

THE SECOND DEFINITION OF SWAP IS
MOST COMMONLY USED STATING AS AN
AGREEMENT TO THE FUTURE EXCHANGE
OF CASH FLOWS.THESE CAN BE REGARD-
ED AS SERIES OR PORTFOLIOS OF
FORWARD CONTRACT.SUCH A CURRENCY
SWAP IS SIMILAR TO A SUCCESSION OF
FORWARD FOREIGN EXCHANGE CONTRA-
CTS WITH RELATIVELY DISTANT
MATURITY BASIS.
THE STUDY OF SWAP IS THUS A NATURAL
EXTENSION OF FORWARD AND FUTURE
CONTRACT.FINANCIAL SWAP IS A SPECI-FIC
FUNDING TECHNIQUE WHICH PERMITS A
BORROWER TO ACCESS ONE MARKET AND
THEN EXCHANGE THE LIABILITY FOR ANOTHER
TYPE OF LIABILITY. SWAPS CAN BE HELPFUL
TO CHANGE THE NATURE OF LIABILITY
ACCRUED ON A PARTICULAR INSTRUMENT
WITH THE OTHERS.

IT MEANS THAT SWAPS ARE NOT A FUNDI-
NG INSTRUMENT RATHER JUST LIKE A
DEVICE TO OBTAIN THE DESIRED FORM
OF FINANCING INDIRECTLY WHICH
OTHERWISE MIGHT BE INACCESSABLE
OR TOO EXPENSIVE.BASICALLY SWAPS
INVOLVE THE EXCHANGE OF INTEREST
OR CURRENCY EXPOSURES OR A COMBI-
NATION OF BOTH BY BORROWERS.
THEY MAY NOT NECESSARILY INVOLVE
THE LEGAL SWAPPING OF ACTUAL DEBTS
BUT AN AGREEMENT IS EXECUTED TO
MEET CERTAIN CASHFLOWS UNDER THE
LOAN OR LEASE AGREEMENTS.
SWAP MARKET EXIST BECAUSE DIFFERENT
CO’S HAVE SPECIFIC ACCESS TO VARIO-
US FINANCIAL MARKETS AND THEY HAVE
DIFFERENT NEEDS.

SOME CO’S HAVE BETTER ACCESS TO JAP-
ANESE MARKETS THAN OTHERS WHERE-
AS OTHER’S MAY HAVE GOOD REPUTAT-
ION IN US MARKETS. SOME NEED
FLOATING RATE OF PAYMENTS. SO SWAP
IS A PRIVATE AGREEMENT BETWEEN THE
TWO PARTIES TO EXCHANGE PREDETER-
MIND AMOUNT OF CASH FLOWS IN
FUTURE AS PER DESIRED FORMULA
ALONG WITH OTHERS TERMS.
EVOLUTION OF SWAP MARKET.
LIKE MOST NEW PRODUCTS/INSTRUMENTS
IN INTERNATIONAL FINANCE SWAPS ARE
NOT EXECUTED IN A PHYSICAL MARKET.
PARTICIPANTS AND DEALERS IN THE
SWAP MARKET ARE MANY AND VARIED
IN THEIR LOCATION, CHARACTER AND
MOTIVES. SWAPS ORIGINATED IN EARLY
1970’S WHEN MANY COUNTRIES IMPOS-
ED FOREIGN EXCHANGE RESTRICTIONS
EVOLUTION OF SWAPS MARKET
SOME ARE OF THE OPINION THAT SWAPS
OWE THEIR ORIGIN TO THE EXCHANGE
RATE INSTABILITY THAT FOLLOWED THE
DEMISE OF THE BRETTON WOODS SYST-
EM DURING THE MID 1970’S. IN 1980 A
FEW COUNTRIES LIBERALIZED THEIR
FOREIGN EXCHANGE REGIME AS A RESU-
LT SOME OF THE TREASURERS STRUCTU-
RED THEIR PORTFOLIO’S AND BROUGHT
A NEW PRODUCT CALLED SWAPS .
EVOLUTION OF SWAP MARKET
THEY REPLACED THEIR BACK TO BACK
LOANS WITH SWAP DEALS WHICH FOU-
ND THEM MORE FLEXIBLE AND SIMPLER
DUE TO SIMPLER DOCUMENTATION.IT
ALSO LOWERED FINANCING COST AND
TAX DIFFERENCES IN COMPARISON TO
THE EARLIER CONTRACTS.ALSO MNC’S
STARTED DIRECTLY INTERACTING
INSTEAD OF BANKS.
EVOLUTION OF SWAP MARKET.
A MAJOR DRAMATIC CHANGE IN THE SWAP
MARKET HAS BEEN THE EMERGENCE OF
LARGE BANKS AND PERFORMED AS AGG-
RESIVE MARKET MAKERS IN DOLLAR
INTEREST RATE SWAPS.THEY OFFERED
BID /OFFER QUOTES FOR BOTH INTERE-
ST RATE AND CURRENCY SWAPS.BANKS
ALSO FOUND A COUNTER PARTY WHO
EXACTLY REQUIRED THE SAME TO
HEDGE THE TRANSACTION.
EVOLUTION OF SWAPS
IN 1984 THE INTERNATIONAL SWAP DEAL-
ERS ASSOCIATION WAS FORMED TO
SPEED UP THE GROWTH IN THE SWAP
MARKETS BY STANDARDISING THE
DOCUMENTS.IN 1985 THE FIRST SWAP
CODE WAS DEVISED.IN 1987 IT FORMED
A STANDARD FORMS AGREEMENT.THESE
CONTRACTS ARE STRUCTURED AS MAST-
ER AGREEMENTS.
FEATURES OF SWAPS.
1. COUNTER PARTIES:- ALL SWAPS INVOL-VE
THE EXCHANGE OF A SERIES OF PERIODIC
PAYMENTS BETWEEN AT LEAST 2
PARTIES.(EXAMPLE :- INTEREST RATE
FIXED/FLOATING)
2. FACILITATORS:- SWAP AGREEMENTS ARE
USUALLY ARRANGED THROUGH AN
INTERMEDIARY FINANCIAL INSTITUTION
LIKE A BANKER.BROKERS AND SWAP DEALER
ARE TWO CATEGORIES OF FACILITATORS.
FEATURES OF SWAPS
a) BROKERS BRING PARTIES TO A SWAP
DEAL. THEIR BASIC IDEA IS TO
INITIATE THE COUNTER PARTIES TO
FINALISE A DEAL.
b) SWAP DEALERS:- THEY THEMSELVES
BECOME THE COUNTER PARTIES AND
TAKEOVER RISK.THEY HAVE TO PRICE
THE SWAP,AND MANAGE THE PORTFO-
LIO.

FEATURES OF SWAPS
3.CASH FLOWS:-HERE WE HAVE 2 DIFFER-
ENT CASH FLOWS.IT IS A DEAL WHERE
WE EXCHANGE TWO FINANCIAL OBLIGA-
TIONS IN THE FUTURE.SO WE EXAMINE
THE PRESENT VALUE OF FUTURE CASH
STREAMS.
4.DOCUMENTATIONS:- FORMALITIES ARE
LESSER AS COMPARED TO A LOAN,LESS
TIME CONSUMING AND SIMPLER.

FEATURES OF SWAPS.
5. TRANSACTION COSTS:-THEY ARE VERY
LOW AT ALMOST ½% OF THE TOTAL
SUM OF THE CONTRACT.
6.BENEFITS TO PARTIES:- THESE DEALS
ARE NEEDED ASLONG AS BOTH PARTIES
ARE HAPPY AND FIND IT PROFITABLE.
7.TERMINATION: BOTH PARTIES NEED TO
TERMINATE THE CONTRACT AND NOT
ONE PARTY.

FEATURES AND TYPES OF SWAPS
8. DEFAULT RISK:-AS THEY ARE BILATERAL
AGREEMENTS THERE ARE POSSIBILITIES
OF DEFAULT RISK BY BOTH THE PARTY.
TYPES OF SWAPS:-THE BASIC PURPOSE OF
SWAPS IS TO HEDGE THE RISK AS
DESIRED BY BOTH THE PARTIES. THE
MAJOR RISKS ARE,INTEREST RATE,CURR-
ENCY ,COMMODITY, EQUITY - DEBT,
CREDIT, CLIMATE, ETC.

TYPES OF SWAPS
1. INTEREST RATE SWAPS:-
IT IS A FINANCIAL AGREEMENT BETWEEN
TWO PARTIES WHO WISH TO CHANGE
THE INTEREST PAYMENTS OR RECEIPTS
IN THE SAME CURRENCY ON ASSETS OR
LIABILITIES TO A DIFFERENT BASIS.
THERE IS NO EXCHANGE OF THE
PRINCIPAL AMOUNT IN THIS SWAP.

TYPES OF SWAPS:- INTEREST
IT IS AN EXCHANGE OF INTEREST PAYME-
NTS FOR A SPECIFIC MATURITY ON A
AGREED UPON NOTIONAL AMOUNT. THE
TERM NOTIONAL REFERS TO THE THEO-
RITICAL PRINCIPAL UNDERLYING THE
SWAP.IT IS USED ONLY TO CALCULATE
THE INTEREST TO BE EXCHANGED
UNDER THE INTEREST RATE SWAP.

TYPES OF SWAPS- INTEREST
THE EXAMPLE OF EXCHANGING A FIXED TO
FLOATING RATE OF INTEREST IN THE
SAME CURRENCY IS CALLED AS THE
PLAIN VANILLA SWAP. IT INVOLVES
CREDIT DIFFERENTIALS BETWEEN TWO
BORROWERS WHICH GENERATE
SUFFICIENT COST SAVINGS FOR BOTH
THE PARTIES.

FEATURES OF INTEREST RATE
SWAPS
1. NOTIONAL PRINCIPAL:- IN THE INTERE-
ST RATE SWAP AGREEMENT THE INTER-
EST AMOUNT WHETHER FIXED OR FLOA-
TING IS CALCULATED ON A SPECIFIED
AMOUNT BORROWED OR LENT.IT IS THE
NOTIONAL BECAUSE THE PARTIES DO
NOT EXCHANGE THIS AMOUNT AT ANY
TIME. IT REMAINS CONSTANT AT ALL
TIMES. IT IS USED TO COMPUTE THE
SEQUENCE OF PAYMENTS OF CASH FLOW
SWAPS
2. FIXED RATE:-THIS IS THE RATE WHICH IS
USED TO CALCULATE THE SIZE OF THE FIXED
PAYMENT. BANKS OR THE OTHER FIN.
INSTITUTIONS WHO MAKE THE MARKET IN
INTEREST RATE SWAPS QUOTE THE FIXED
RATE THEY ARE WILL-ING TO PAY IF THEY ARE
FIXED RATE PAYERS IN A SWAP (BID SWAP
RATES), THEY ARE WILLING TO RECEIVE IF
THEY ARE FLOATING RATE PAYERS IN A
SWAP(ASK SWAP RATE).

SWAPS
EX:- A BANK MIGHT QUOTE A US $ FLOAT-ING
TO FIXED 5-YEAR SWAPRATE:-
TREASURIES+20bp/TREASURIES+40bp vs 6
MONTH LIBOR.
THE QUOTE INDICATES THE FOLLOWING:-
1. THE SAID BANK IS WILLING TO MAKE FIXED
PAYMENT AT A RATE EQUAL TO THE CURRENT
YIELD ON A 5 YEAR TREASURY NOTES +20
BASIS POINTS(.20%) IN RETURN FOR
RECEIVING FLOATING PAYMENTS AT 6
MONTHS LIBOR.

SWAPS
2. THE BANK HAS OFFERED TO ACCEPT AT A
RATE EQUAL TO 5 YEAR TREASURY NOTES
PLUS 40 BASIS POINTS IN RETURN FOR
PAYMENT OF 6 MONTHS LIBOR.
FLOATING RATE:- IT IS DEFINED AS ONE IN THE
MARKET INDEX LIKE LIBOR TREA-SURY BILL
RATE ETC ON WHICH BASIS THE FLOATING
INTEREST RATE IS DETERMINED IN THE SWAP
AGREEMENT.THE MATURITY OF THE UNDERLY-
ING INDEX EQUALS THE INTERVAL BETWEEN
PAYMENT DATES.

SWAPS
TRADE DATE, EFFECTIVE DATE, RESET
DATE, AND PAYMENT DATE:-
ALL THE ABOVE MENTIONED DATES ARE
IMPORTANT TERMS IN THE SWAP DEAL:
THE FIXED RATE PAYMENTS ARE NORMA-
LLY PAID SEMI ANNUALLY/YEARLY.THE
TRADE DATE MAY BE DEFINED AS SUCH
DATE ON WHICH THE A SWAP DEAL IS
CONCLUDED.

SWAP
EFFECTIVE DATE IS THAT DATE FROM
WHICH THE FIRST FIXED/FLOATING
PAYMENT STARTS TO ACCRUE.FOR EX:- A
5 YEAR SWAP IS TRADED ON 30-08-2002
THE EFFECTIVE DATE MAY BE 01-09-2002
AND TEN PAYMENTS DATES FROM 1-03-
2003 TO 01-09-2007.THE FLOATING
RATE PAYMENTS IN SWAPS ARE SET IN
ADVANCE AND PAID IN ARREARS.
SWAPS
RELEVENT DATES FOR THE FLOATING
PAYMENT:-
1) D(S) 2.D(1) AND 3.D(2).
WHERE D(S) IS SETTING DATE ON WHICH
FLOATING RATE APPLICABLE FOR THE
NEXT PAYMENT IS SET.
D(1)=THAT DATE FROM WHICH THE NEXT
FLOATING PAYMENT STARTS TO
ACCRUE. D(2)= PAYMENT IS DUE.

TYPES OF INTEREST RATE SWAPS
1. PLAIN VANILLA SWAP:- IT IS ALSO KNO-
WN AS FIXED FOR FLOATING SWAP.HERE
ONE PARTY WITH A FLOATING INTEREST
RATE LIABILITY IS EXCHANGED WITH
FIXED RATE LIABLILITY.USUSALLY SWAP
PERIOD RANGES FROM 2 TO 15 YEARS
FOR A PREDETERMINED NOTIONAL
PRINCIPAL AMOUNT. MOST OF THE
DEALS OCCUR WITHIN 4 YEARS PERIOD.
2. ZERO COUPON TO FLOATING:-THE HOL-
DERS OF ZERO-COUPON BONDS GET THE
FULL AMOUNT OF LOAN AND INTEREST
ACCRUED AT THE MATURITY OF THE
BOND.HENCE IN THIS SWAP THE FIXED
RATE PLAYER MAKES A BULLET PAYMENT
AT THE END AND THE FLOATING RATE
PLAYER MAKES THE PERIODIC PAYMENT
THROUGHOUT THE SWAP PERIOD.
3.ALTERNATIVE FLOATING RATE:- IN THIS
TYPE OF SWAP THE FLOATING REFEREN-
CE CAN BE SWITCHED TO OTHER ALTER-
NATIVES AS PER THE REQUIREMENT OF
THE COUNTER PARTY.THESE ALTERNATI-
VES INCLUDE 3 MONTH LIBOR,1 MONTH
COMMERCIAL PAPER,T-BILLS RATE ETC.
THAT MEANS ALTERNATIVE FLOATING
INTEREST RATE ARE CHARGED IN ORDER
TO MEET THE EXPOSURE OF OTHERS.
FLOATING TO FLOATING:- IN THIS SWAP
ONE COUNTER PARTY PAYS ONE FLOAT-
ING RATE SAY LIBOR WHILE THE OTHER
COUNTER PARTY PAYS ANOTHER SAY
PRIME FOR A SPECIFIED TIME PERIOD.
THESE SWAP DEALS ARE MAINLY USED
BY NON US BANKS TO MANAGE THEIR
DOLLAR EXPOSURE.

5.FORWARD SWAPS:-THIS SWAP INVOLVES AN
EXCHANGE OF INTEREST RATE PAYM-ENT
THAT DOES NOT BEGIN UNTIL A SPECIFIED
FUTURE POINT OF TIME.IT IS ALSO KIND OF
SWAP INVOLVING FIXED FOR FLOATING
INTEREST RATE.
6. EQUITY SWAP:-THE EQUITY SWAP INVOLVES
THE EXCHANGE OF INTEREST PAYMENTS
LINKED TO THE CHANGE OF STOCK INDEX.

7. SWAPTIONS:- THESE ARE COMBINATION
OF OPTIONS AND SWAPS.THE BUYER OF
SWAPTION HAS THE RIGHT TO ENTER
INTO AN INTEREST RATE SWAP AGREE-
MENT BY SOME SPECIFIED DATE IN THE
FUTURE.THE BUYER OF A SWAPTION
WILL SPECIFY WHETHER THE BUYER
WILL BE A FIXED RATE RECEIVER OR A
FIXED RATE PAYER.
VALUATION OF INTEREST RATE
SWAP
ASSUMING NO DEFAULT RISK AN INTERE-
ST RATE SWAP CAN BE VALUED EITHER
AS A LONG POSITION IN ONE BOND
COMBINED WITH SHORT IN ANOTHER
BOND OR AS A PORTFOLIO OF FORWARD
CONTRACTS. IN OTHER WORDS INTERE-
ST RATE SWAP(FIXED OR FLOATING)
CAN BE VALUED BY TREATING THE FIXED
RATE PAYMENTS AS BEING EQUIVALENT
TO A FLOATING RATE NOTE (FRN).
SWAP
ASSUMING NO DEFAULT RISK AN INTERE-
ST RATE SWAP CAN BE VALUED EITHER
AS A LONG POSITION IN ONE BOND
COMBINED WITH A SHORT IN ANOTHER
BOND OR AS A PORTFOLIO OF FORWARD
CONTRACTS.INTEREST RATE SWAP
(FIXED OR FLOATING)CAN BE VALUED BY
TREATING THE FIXED RATE PAYMENTS
AS BEING EQUIVALENT TO THE CASH
FLOWS OF A CONVENTIONAL BOND AND
SWAP
THE FLOATING RATE PAYMENTS AS BEING
EQUIVALENT TO A FLOATING RATE
NOTE.(FRN) IN A INTEREST RATE SWAP
THE PRINCIPAL AMOUNT IS NOT EXCHA-
NGED AND FURTHER AMOUNT IS PAID IN
THE SAME CURRENCY.THUS THE VALUE
OF SWAP COULD BE EXPRESSED AS THE
VALUE OF FIXED RATE BOND AND VALUE
OF FLOATING RATE UNDERLYING THE
SWAP.
SWAP
IT MAY BE EXPRESSED AS:- V = B1- B2
WHERE V=VALUE OF SWAP,B1 = THE
VALUE OF FIXED RATE BOND UNDERLY-
ING THE SWAP AND B2=VALUE OF
FLOATING RATE BOND UNDERLYING THE
SWAP.

CURRENCY SWAPS
A SWAP DEAL CAN ALSO BE ARRANGED ACROSS
CURRENCIES. IN THIS SWAP THE TWO
PAYMENT STREAMS BEING EXCHANGED ARE
DENOMINATED IN TWO DIFFERENT
CURRENCIES. FOR EX A FIRM WHICH HAS
BORROWED YEN AT A FIXED INTEREST RATE
CAN SWAP AWAY THE EXCHANGE RATE RISK
BY SETTING UP A CONTRACT WHEREBY IT
RECEIVES YEN AT A FIXED RATE OF RETURN
FOR $ AT EITHER AT FIXED /FLOATING INT.

CURRENCY SWAPS
THE CURRENCY SWAP IS LIKE INTEREST RATE
SWAP,ALSO TWO PARTY TRANSAC-TION
INVOLVING TWO COUNTER PARTI-ES WITH
DIFFERENT BUT COMPLIMENT-ARY NEEDS
BEING BOUGHT BY A BANK. HERE THREE
STEPS ARE INVOLVED:-
1.INITIAL EXCHANGE OF PRINCIPAL AMOUNT.
2.ONGOING EXCHANGE OF INTEREST.
3.RE-EXCHANGE OF PRINCIPAL AMOUNT ON
MATURITY.

CURRENCY SWAPS
THE FIRST STEP IS THE INITIAL EXCHANGE
OF THE PRINCIPAL AMOUNT AT AN
AGREED RATE OF EXCHANGE.THIS RATE
IS USUALLY BASED ON THE SPOT RATE.
THIS EXCHANGE CAN BE ON A NOTIONAL
BASIS i.e. NO PHYSICAL EXCHANGE OF
PRINCIPAL AMOUNT. THE COUNTER
PARTIES SIMPLY CONVERT PRINCIPAL
AMOUNT INTO THE REQUIRED CURREN-
CY-VIA THE SPOT MARKET.
CURRENCY SWAPS
THE SECOND STEP IS RELATED WITH ONG-
OING EXCHANGE OF INTEREST. AFTER
ESTABLISHING THE PRINCIPAL AMOUNT
THE COUNTER PARTIES EXCHANGE
INTEREST PAYMENT ON A AGREED DATE
BASED ON THE O/S PRINCIPAL AMOUNT
AT THE FIXED INTEREST RATES AT THE
OUTSET OF THE TRANSACTION.

CURRENCY SWAPS
THE THIRD STEP IS THE RE-EXCHANGE OF
PRINCIPAL TO PRINCIPAL AMOUNT.
AGREEMENTS ON THIS ENABLES THE
COUNTER PARTIES TO REEXCHANGE THE
PRINCIPAL SUMS AT THE MATURITY
DATE.
THE STRUCTURE OF A CURRENCY SWAP
DIFFERS FROM INTEREST RATE SWAPS
IN A VARIETY OF WAYS.

TYPES OF CURRENCY SWAPS
THE MAJOR DIFFERENCE IS THAT IN A
CURRENCY SWAP THERE IS ALWAYS AN
EXCHANGE OF PRINCIPAL AMOUNTS AT
MATURITY AT A PREDETERMINED
EXCHANGE RATE.THUS THE SWAP CONT-
RACT BEHAVES LIKE A LONG DATED
FORWARD,IS FORWARD EXCHANGE
CONTRACT WHERE THE FORWARD IS
THE CURRENT SPOT RATE.
THE CURRENCY SWAPS CAN BE OF DIFFER-
ENT TYPES BASED ON THEIR STRUCTURE
SUCH AS:-
1.FIXED TO FIXED CURRENCY SWAP:-
HERE THE CURRENCIES ARE EXCHANGED
AT FIXED RATE. ONE PARTY RAISES A
FIXED RATE LIABILITY IN $ AND THE
OTHER A FIXED RATE FUNDING IN
POUND.

THE PRINCIPAL AMOUNT ARE EQUIVALENT AT
CURRENT MARKET EXCHANGE RATE. IN A
SWAP DEAL THE FIRST PARTY GETS POUND
WHEREAS THE SECOND PARTY GETS $. LATER
ON THE FIRST PARTY GETS TO MAKE PERIODIC
PAYMENTS IN POUND TO THE SECOND IN
TURN GETS $ COMPUTED AT INTEREST AT A
FIXED RATE ON THE RESPECTIVE PRINCIPAL
AMOUNT OF BOTH CURRENCIES.AT MATURITY
THE $ AND POUND PRINCIPAL ARE RE-EXCHAN-
GED.

2. FLOATING TO FLOATING SWAP:-HERE THE
COUNTER PARTIES WILL HAVE PAY-MENTS AT
FLOATING RATE IN DIFFER-ENT CURRENCIES.
3. FIXED TO FLOATING CURRENCY SWAPS: THIS
SWAP IS A COMBINATION OF A FIXED TO
FIXED CURRENCY SWAP AND FLOATING
SWAP.HERE ONE PARTY MAKES THE PAYMENT
AT A FIXED RATE IN CURRENCY SAY X WHILE
THE OTHER PARTY MAKES THE PAYMENT AT A
FLOATING RATE IN CURRENCY Y.
CONTRACTS WITHOUT THE EXCHANGE
AND RE-EXCHANGE OF PRINCIPALS DO
EXIST. IN MOST CASES A FINANCIAL
INTERMEDIARY (A SWAP BANK)
STRUCTURES THE SWAP DEALS AND
ROUTES THE PAYMENTS FROM ONE
PARTY TO OTHER PARTY.THE MOST
IMPORTANT CURRENCIES IN THE
CURRENCY SWAPS MARKET ARE:-
CURRENCY SWAPS-USES
US$,SWISS FRANC,DEUTSCHE MARK, EURO
POUND STERLING, CANADIAN $ & YEN.
THE CURRENCY SWAP IS AN IMPORTANT
TOOL TO MANAGE CURRENCY EXPOSURE
AND COST BENEFITS AT THE SAME TIME.
THESE ARE OFTEN USED TO PROVIDE
LONG TERM FINANCING IN FOREIGN CU-
RRENCIES.THIS IS BECAUSE IN MANY
COUNTRIES FIN MARKETS ARE NOT
WELL DEVELOPED.
VALUATION OF CURRENCY SWAP
HERE THE SWAPS ARE VALUED AS THE
DIFFERNCE BETWEEN THE CURRENT VALUES
OF TWO CONVENTIONAL BONDS. THE VALUE
OF A FOREIGN CURRENCY BOND AND THE
CORRESPONDING VALUE OF A DOMESTIC
CURRENCY BOND ARE TAKEN.
V=SBF–BD where V=value of swap, S=current
exchange rate expressed in no of units of
domestic currency, Bf=value of a for. currency
bond, and Bd =local currency bond

Risk MGMT Mod 3.

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