Multinational Financial

Management
Alan Shapiro
9th Edition
J.Wiley & Sons

Power Points by
Joseph F. Greco, Ph.D.
California State University, Fullerton

Chapter 9
Swaps and Interest Rate
Derivatives

INTEREST RATE AND CURRENCY

SWAPS
I. INTEREST RATE AND CURRENCY SWAPS
A. INTEREST RATE SWAPS
1. Definition
an agreement between 2 parties to
exchange US$ interest payments for
a specific maturity on an agreed
notional amount.

HOW THE CLASSIC SWAP

WORKS
A. INTEREST RATE SWAPS (cont)
2. Notional principal: a reference
amount used only to calculate
interest expense but never
repaid.
3. Maturities: less than 1 to over 15
years

THE CLASSIC SWAP

4. Types
a. Coupon swap
b. Basis swap
5. LIBOR: the most important reference rate in a
swap
6. Swap Usage:
To reduce risk potential and costs.

THE CURRENCY SWAP

B. Currency Swaps
1. Definition
two parties exchange foreign currencydenominated debt at periodic intervals.
2. Purpose: similar to parallel loan

THE CURRENCY SWAP

3. Differences of a Currency Swap:
a. Currency swap is not a loan
b. No interest expense; no balance
sheet entry
c. The right to offset any non-payment
is more firmly established

THE CURRENCY SWAP

4. Similarities between Interest Rate and
Currency Swaps
a. Avoid exchange rate risk
b. Exchange rate is only a reference to
determine amounts exchanged
5. Economic Benefits of Swaps when
arbitrage prohibited, they provide
long-term financing.

INTEREST RATE FORWARDS AND

FUTURES
Forward and futures contracts:
- three types used to manage interest rate
risk
A. Forward forwards
B. Forward rate agreements
C. Eurodollar futures

INTEREST RATE FORWARDS AND

FUTURES
A. Forward forwards
1. a contract that fixes an interest rate today
on a future loan or deposit.
2. Contract conditions:
- specific interest rate
- principal amount of future loan
- start and ending dates of future interest
rate period

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INTEREST RATE FORWARDS AND

FUTURES
B. Forward rate agreements (FRAs)
1. cash-settled
2. over-the-counter forward contract
company fixes an interest rate applied to
a specified future interest period on a
notional amount.

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INTEREST RATE FORWARDS AND

FUTURES
C. Eurodollar Futures
1.
2.

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A cash-settled futures contract for a 3- month

eurodollar deposit paying LIBOR
Contracts traded on:
a. Chicago Mercantile Exchange
b. London International Financial
Futures Exchange
c. Singapore International Monetary
Exchange

STRUCTURED NOTES
A. Definition
Interest-bearing securities whose interest payments
are determined by reference to a formula set in
advance and adjusted on specific reset dates.

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STRUCTURED NOTES
B. Inverse Floaters
a floating-rate instrument whose interest rate moves
inversely with market interest rates.

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