Beruflich Dokumente
Kultur Dokumente
International Corporate Finance P.V. Viswanath For use with Alan Shapiro Multinational Financial Management
Learning Objectives
To describe how interest rate and currency swaps works and their function. To calculate the appropriate payments and receipts associated with a given swap. To describe the use of forward forwards, forward rate agreements and Eurodollar futures to hedge interest rate risk. To explain the nature and pricing of structured notes.
P.V. Viswanath
Coupon Swaps
Counterparties A and B both require $100 m. for a 5-yr period. A wants to borrow at a fixed rate, but B wants a floating rate. A can borrow floating at a reasonable rate, but not fixed; B can borrow fixed or floating at a good rate. There is an opportunity for profitable exchange because the differences in the fixed rates across counterparties is different from the differences in floating rates. If A borrows floating and B borrows fixed and they swap, both are better off, as long as A pays B a consideration of between 50 and 100 bps; in the next example, A pays B 75 bps, and 10 bps to an intermediary.
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Coupon Swaps
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Currency Swaps
A currency swap is an exchange of debt-service obligations denominated in one currency for the service on an agreed upon principal amount of debt denominated in another currency. This is equivalent to a package of forward contracts. The all-in cost is the effective interest rate on the money raised. This is calculated as the discount rate that equates the present value of the future interest and principal payments to the net proceeds received by the issuer. The right-of-offset gives each party the right to offset any nonpayment by the other party with a comparable nonpayment. In an interest rate swap, there is no need for a swap of principals, whereas this usually does occur in a currency swap. P.V. Viswanath 8
Currency Swaps
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Merrill makes the bank a zero-coupon loan in A$ at a rate of 13.39%. Merrill pays the bank A$68m. today and gets A$130 in 5 years. The bank makes Merrill a floating rate $-denominated loan. Merrill gets $48m. and pays the bank a floating rate of LIBOR - 0.40% semi-annually and repays the $48m. in 5 years. The initial payments are arranged so that they are equal in value.
Merrill partially hedges the LIBOR payments to bank B by entering into a $ fixed/floating swap with a notional value of $48m.
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Eurodollar futures
Eurodollar futures are cash-settled futures contracts on a three-month, $1m. eurodollar deposit that pays LIBOR. They are traded on the CME, the LIFFE and the SIMEX. They are effectively standardized FRAs. Unlike FRAs, futures contracts are marked to market at the end of every day. In contrast, an FRA is marked-to-market only when the contract matures. Furthermore, the notional value of an FRA is the amount to be borrowed, while the notional value in a eurodollar futures contract is the amount to be paid at maturity.
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Structured Notes
Interest bearing securities whose interest payments are determined by reference to a formula set in advance and adjusted on specified reset dates. These factors can include LIBOR, exchange rates, commodity prices or any combination thereof.
FRN: interest payment tied to LIBOR. Inverse floater: interest rate moves inversely with market rates, e.g. nr (n-1)LIBOR, where r is the market rate on a fixed rate bond, with periodic rate resetting. The volatility is n times the volatility of a fixed rate bond. Step-down notes: debt instruments with a high coupon in earlier payment periods and a lower coupon in later periods for tax reasons, an investor might want to front-load his interest income.
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