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Accounting for Derivatives

are mostly used to change the interest rate risk and currency profile of interest-bearing assets
and/or liabilities.
Corporations usually enter into CCSs to transform the currency denomination of a debt
obligation denominated in a foreign currency. The two counterparties to a CCS agree to
exchange, at certain future dates, two set of cash flows denominated in different currencies.
The cash flows paid by one counterparty reflect a fixed (or a floating) rate of interest in one
currency while those of the other counterparty reflect a fixed (or floating) rate of interest in
another currency.
In its simplest (and most common) form a CCS involves the following cash flows:
An initial exchange of principal amounts. This initial exchange is sometimes not undertaken.
The most common reason for not using an initial exchange is that the CCS swap is being
undertaken to hedge already existing liabilities.
A string of interim interest payments. Periodically, one counterparty pays a fixed (or floating)
interest on one of the principal amounts, and the other counterparty pays a fixed (or floating)
interest on the other principal amount. The payments are usually netted.
A final re-exchange of principal amounts.
For example, suppose a borrower is about to issue a 5 % fixed-rate 5-year GBP denominated
bond. The borrower is only interested in raising EUR funds, so it decides to transform the
GBP fixed-rate liability into a EUR floating-rate liability by entering into a CCS. The terms
of the bond and the swap are summarised in the following tables:
Bond Terms
Maturity
Notional
Coupon

5 years
GBP 70 million
5 %, to be paid annually, 30/360 basis

Cross-currency Swap Terms

Maturity
GBP nominal
EUR nominal
Initial exchange
ABC pays
ABC receives
Final exchange

5 years after start date

GBP 70 million
EUR 100 million
On start date, borrower receives the EUR nominal
and pays the GBP nominal
Euribor 12m + 50 bps, annually, on the EUR nominal
GBP 5 %, annually, on the GBP nominal
On maturity date, borrower receives the GBP
nominal and pays the EUR nominal

Figure 2.5 shows the initial cash flows of the CCS and their interaction with the bond initial
flow. Through the CCS, the borrower delivers the GBP 70 million issue proceeds and receives
EUR 100 million. As a result, the borrower is in effect obtaining a EUR 100 million funding.
Figure 2.6 shows the bond and the CCS periodic interest payments. Through the CCS, the
borrower receives annually a GBP 5 % interest calculated on the GBP 70 million nominal,
and pays annually a EUR floating interest (Euribor 12-month plus 50 bps) calculated on the
EUR 100 million nominal. The borrower uses the CCS GBP receipts to meet the bond interest
payments.