SWAPS:

Todays financial swaps markets have their origin to the exchange rate instability
that followed the demise of Bretton Woods system in the early 1990s and to the
controls on international capital movements that most counties maintained in those
days. Swaps are at the center of the global financial revolution. Fantastic numbers
and growth are talked of. All this is true. But what is also certain is that the current
heady acceleration f this market cannot continue. Otherwise, there will be no other
activity left-only swapping.
Already the shakeout has started. In the plain vanilla dollar sector, the profits for
brokers and market makers, after costs and allocation of risk capital, are measured
in fewer than five basis points. This is before the regulators catch u and force
disclosure and capital haircuts. At these spreads the more highly paid must move
on to currency swaps, tax-driven deals, tailored structures and Schlock swaps.
What is certain that, although the excitement may diminish, swaps are here to stay.
Already, swaps have had a major macro economic impact forging the linkage
between the Euro and domestic markets, flattening the cash yield curves and
reducing central bank monopoly influence on markets. We are all swappers now.
And, when you are offered sweet deals, remember the Tibetan saying Beware of
honey offered on a sharp knife. The problem in following the chaotic progress of
this very important market is quite simply that he who
knows does not speak, he who speaks does not know. A brief glimpse of how the
swap market has matured and a short list of the non-proprietary tools in the
swappers arsenal is presented below :
SWAPS THE TEENAGE YEARS
The essence of a swap contract is the binding of two counterfeiters to exchange
two different payment steams over time, the payment streams over time, the

payment being tied, at least in part, to subsequent and uncertain market price
developments. In most swaps so far, the prices concerned have been exchange rates
or interest rates, but they increasingly reach out to equity indices and physical
commodities, notably oil and oil products. All such prices have risk characteristics
in common, in quality of not in degree. And for all, the allure of swaps may be
expected cost saving, yield enhancement, or hedging or speculative opportunity.
Financial swaps, simple in principal and versatile in practice, are revolutionary,
especially for portfolio management. A swap coupled with an
existing asset or liability can radically modify effective risk and return.Individually
and together with futures, options and other financial derivatives, they allow yield
curve and currency risks, and liquidity and geographic market considerations, all to
be managed separately and also independently of underlying cash market stocks.
Swaps in their current form started in 1981 with the well-publicized currency
swaps, and in the following year, with dollar interest-ate swaps. The initial deals
were characterized by three critical features.
1. Barter two counter parties with exactly offsetting exposures were introduced
by a third party. If the credit risk were unequal, the third party if a bank might
interpose itself or arrange for a bank to do so for a small fee.
2. Arbitrage driven the swap was driven by an arbitrage which gave some profit
to all three parties. Generally, this was a credit arbitrage or market access arbitrage.
3. Liability driven-almost all swaps were driven by the need to manage a debt issue
on both sides.
The major, dramatic change has been the emergence of the large banks as
aggressive market makers in dollar interest-rate swaps. Major US banks are in the
business of taking credit risk and interest-rate risk. They therefore do not
need counter parties to do dollar swaps. The net result is that spreads have
collapsed and volume has exploded.

Swaps The Laundry List

Dollar swaps
1. Plain vanilla
2. Alternate floating rate
3. Floating-floating
4. Variable principle
5. Options on swaps
6. Short date swaps
7. Syndicated swaps
8. Hi-tech swaps
9. Plain deal
10.Without exchange of principle
11. Amortizing swaps
12. Off-market deals
13. Cross-currency interest-rate swaps
14. Amortizing principle
15. Off-market deals
16. Assign ability and trade ability
17. Collateralized swaps and Schiock Swaps
18. Extendible swap
19. Puttable swap
20. Drawdown swap
Along with swap other important derivatives and institutional developments which
came into prominence are:
Continuous Tender Panel: A compromise between sole-placing agency and tender
panel. The CTP agent agrees on the issue price (the strike offered yield of SOY)
with the issuer, at which price underwriting banks may request protection on their

notional allocations. These allocations are calculated pro rate to their underwriting
commitments, but are only exercisable to the extent that the CTP agent has not persold the issue tranche. The SOY can change during the bidding period and
underwriters may be able to increase their initial
allocations by bidding at, or under, the SOY.
Direct Bid Facility (Unsolicited bidding): An increasingly common provision in
tender panel facilities whereby panel members may make unsolicited bids to the
issuer for particular note amounts/maturities.
Euro-commercial paper: A non-under-written or uncommitted note issuance
programme where typically two or three dealers place the issuers papers.
Global Note Facility: The Banks medium-term underwriting commitment is
available to back up both the issue of US commercial paper and Euro notes. Should
the issuer be unable to roll over USCP, his will trigger off a Euro note issuance
process by tender panel. Bridging finance between the time of failed US CP rollover and provision of funds from the Euro note facility is provided by a
Swingling (below).
Global Commercial Paper: The growing concept of non-underwritten Euro note,
issuance programme being old on a global basis with the book moving between
time zones.
GUN: Grantor underwritten note: A floating rate note facility akin to a Euronote
facility whereby a group of banks (grantors) commit to purchase any notes put
back to them by investors on any FRN interest rate fixing date. Put notes are then
auctioned out to the market between the grantors.
Issuer-Set Margin: Similar to continuous tender panel except that, underwriters
are guaranteed the protection on their pro rata allocation of paper. Should they opt
not to take notes at the issuer-set margin, the lead manager will instead.

MOF: Multi-option facility: Broader than the classic underwritten Euronots

facility (NIF) in that the banks medium-term commitment is to backstop, not only
the issuance of Euronotes, but a wide range of other short-term instruments-i.e.bankers acceptance and short-term advances in a variety of currencies.
NIF: Note Issuance facility: An addition to RUF and SNIF. Now widely regarded
as a general description for all underwritten Euronote facilities.
PUF: Prima underwriting facility: Same as a RUF except that the maximum
margin is expressed in relation to US prime.
RUF: Revolving underwriting facility: The acronym that started it all.
Classically, a medium term commitment by a group of underwriting banks to
purchase one, three or six-months. Euronotes at a fixed libor related margin should
a safe-placing agents fail to sell the notes to investors at or under, that margin RUF
has since been extended to tender panel placement facilities as well as sole-placing.
SNIF: Short-term note Insurance facility: Came after RUF as a method of
distinguishing tender panel placement from the sole - placing of the RUF.
Otherwise, structurally the same.
Specialized Tender Panel: Similar to the direct bid facility except that members of
the STP are limited to a nucleus of houses with perceived note placement strength
who are expected to make a market in the issuers paper.
Stop Out Bid: A refinement of tender panel bidding where by one or more of the
TP participants have an option to post a bid for all or part of an issue tranche at a
price which other tender panel members must then better.
Striking Price Method: The issue price for the whole tranche is set at the level of
the last accepted bid which caused the tranche to be filled-i.e.-notes are not priced
at a sequential level from the most competitive bid upwards as in standard tender
panel.

Swap Tender Panel: A further refinement of TP whereby the issues can ask for
currency and /or interest rate swaps on a particular note issue tranche.
Swingline: Used in a global note facility or BONUS to allow the issuer to move
from the US CP market to the Euronote market. Typically available for a maximum
of seven days and priced over US prime.
TAP basis: The increasingly frequent method of issuance in Euro CP. The dealer
approaches the issuer for paper in direct response to particular investor demand,
rather than the issuer seeking bids from the dealer.
Tender Acceptance Facility: Precisely the same ructure as an underwriting ten.
Euronote facility using a tender panel except that the shortterm instruments under
auction are bankers acceptances, euro Euronotes.
Tender Panel: A group including Euronote facility under writers and additionally
appointed banks and dealers, who are invited to bid on an issuers paper in an open
auction format. Notes are awarded to bidders in sequential order from the most
competitive bid up wards until the full tranche is allocated.
TRUF: Transferable revolving underwriting facility: The underwriting banks
stringent liability to purchase notes, in the event of non-placement, is fully
transferable. Although the swap market is now firmly established, there remains a
wide divergence among current and potential users as to how exactly a given swap
structure works, what risks are entailed when entering into swap transactions and
precisely what the swap market is and, for that matter, is not. Hence, among the
many topics and controversies surround.
THE BASIC SWAP STRUCTURES
The growth and continued success of the swap market has been due in no small
part to the creativity of its participants. As a result, the swap structures currently
available and the future potential structures which will in time become just another
market norm are limited only by the imagination and ingenuity of those

participating in the market. None-the less, underlying the swap transactions seen in
the market today are four basic structures which may now be considered as
fundamental. These structures are:
the interest Rate Swap
the Fixed Rate Currency Swap
the Currency Coupon Swap
the Basis Rate Swap