SWAPCurrencyandInterestRate现代金融市场概论教学课件

swapCurrency&InterestRateswapCurrency&InterestRate1Currency&InterestRateSwaps

Thischapterdiscussescurrencyandinterestrateswaps,whicharerelativelynewinstrumentsforhedginglong-terminterestrateriskandforeignexchangerisk.Currency&InterestRateSwaps2OutlineTypesofSwapsSizeoftheSwapMarketTheSwapBankInterestRateSwapsCurrencySwapsOutlineTypesofSwaps3Outline(continued)SwapMarketQuotationsVariationsofBasicCurrencyandInterestRateSwapsRisksofInterestRateandCurrencySwapsSwapMarketEfficiencyConcludingPointsAboutSwapsOutline(continued)SwapMarket4DefinitionsInaswap,twocounterpartiesagreetoacontractualarrangementwhereintheyagreetoexchangecashflowsatperiodicintervals.Therearetwotypesofinterestrateswaps:Singlecurrencyinterestrateswap“Plainvanilla”fixed-for-floatingswapsareoftenjustcalledinterestrateswaps.Cross-CurrencyinterestrateswapThisisoftencalledacurrencyswap;fixedforfixedratedebtserviceintwo(ormore)currencies.DefinitionsInaswap,twocoun5SizeoftheSwapMarketIn2001thenotationalprincipalof:Interestrateswapswas$58,897,000,000.Currencyswapswas$3,942,000,000Themostpopularcurrenciesare:U.S.dollarJapaneseyenEuroSwissfrancBritishpoundsterlingSizeoftheSwapMarketIn20016TheSwapBankAswapbankisagenerictermtodescribeafinancialinstitutionthatfacilitatesswapsbetweencounterparties.Theswapbankcanserveaseitherabrokeroradealer.Asabroker,theswapbankmatchescounterpartiesbutdoesnotassumeanyoftherisksoftheswap.Asadealer,theswapbankstandsreadytoaccepteithersideofacurrencyswap,andthenlaterlayofftheirrisk,ormatchitwithacounterparty.TheSwapBankAswapbankisa7AnExampleofanInterestRateSwapConsiderthisexampleofa“plainvanilla”interestrateswap.BankAisaAAA-ratedinternationalbanklocatedintheU.K.andwishestoraise$10,000,000tofinancefloating-rateEurodollarloans.BankAisconsideringissuing5-yearfixed-rateEurodollarbondsat10percent.Itwouldmakemoresenseforthebanktoissuefloating-ratenotesatLIBORtofinancefloating-rateEurodollarloans.AnExampleofanInterestRate8AnExampleofanInterestRateSwapFirmBisaBBB-ratedU.S.company.Itneeds$10,000,000tofinanceaninvestmentwithafive-yeareconomiclife.FirmBisconsideringissuing5-yearfixed-rateEurodollarbondsat11.75percent.Alternatively,firmBcanraisethemoneybyissuing5-yearfloating-ratenotesatLIBOR+½percent.FirmBwouldprefertoborrowatafixedrate.AnExampleofanInterestRate9AnExampleofanInterestRateSwapTheborrowingopportunitiesofthetwofirmsare:AnExampleofanInterestRate10AnExampleofanInterestRateSwapTheswapbankmakesthisoffertoBankA:YoupayLIBOR–1/8%peryearon$10millionfor5yearsandwewillpayyou103/8%on$10millionfor5yearsSwapBankLIBOR–1/8%103/8%BankAAnExampleofanInterestRate11AnExampleofanInterestRateSwapHere’swhat’sinitforBankA:Theycanborrowexternallyat10%fixedandhaveanetborrowingpositionof-103/8+10+(LIBOR–1/8)=LIBOR–½%whichis½%betterthantheycanborrowfloatingwithoutaswap.10%½%of$10,000,000=$50,000.That’squiteacostsavingsperyearfor5years.SwapBankLIBOR–1/8%103/8%BankAAnExampleofanInterestRate12AnExampleofanInterestRateSwapTheswapbankmakesthisoffertocompanyB:Youpayus10½%peryearon$10millionfor5yearsandwewillpayyouLIBOR–¼%peryearon$10millionfor5years.CompanyBSwapBank10½%LIBOR–¼%AnExampleofanInterestRate13AnExampleofanInterestRateSwapAnExampleofanInterestRateSwap:TheycanborrowexternallyatLIBOR+½%andhaveanetborrowingpositionof10½+(LIBOR+½)-(LIBOR-¼)=11.25%whichis½%betterthantheycanborrowfloating.

LIBOR+½%½%of$10,000,000=$50,000that’squiteacostsavingsperyearfor5years.SwapBankCompanyB10½%LIBOR–¼%AnExampleofanInterestRate14AnExampleofanInterestRateSwap

Theswapbankmakesmoneytoo.LIBOR–1/8–[LIBOR–¼]=1/810½-103/8=1/8¼SwapBankCompanyB10½%LIBOR–¼%LIBOR–1/8%103/8%BankAAnExampleofanInterestRate15AnExampleofanInterestRateSwap

Theswapbankmakes¼%SwapBankCompanyB10½%LIBOR–¼%LIBOR–1/8%103/8%BankABsaves½%Asaves½%AnExampleofanInterestRate16AnExampleofaCurrencySwapSupposeaU.S.MNCwantstofinancea£10,000,000expansionofaBritishplant.TheycouldborrowdollarsintheU.S.wheretheyarewellknownandexchangefordollarsforpounds.Thiswillgivethemexchangeraterisk:financingasterlingprojectwithdollars.Theycouldborrowpoundsintheinternationalbondmarket,butpayapremiumsincetheyarenotaswellknownabroad.AnExampleofaCurrencySwapS17AnExampleofaCurrencySwapIftheycanfindaBritishMNCwithamirror-imagefinancingneedtheymaybothbenefitfromaswap.IfthespotexchangerateisS0($/£)=$1.60/£,theU.S.firmneedstofindaBritishfirmwantingtofinancedollarborrowingintheamountof$16,000,000.AnExampleofaCurrencySwapI18AnExampleofaCurrencySwapConsidertwofirmsAandB:firmAisaU.S.–basedmultinationalandfirmBisaU.K.–basedmultinational.Bothfirmswishtofinanceaprojectineachother’scountryofthesamesize.Theirborrowingopportunitiesaregiveninthetablebelow.AnExampleofaCurrencySwapC19AnExampleofaCurrencySwap

$9.4%FirmB$8%£12%SwapBankFirmA£11%$8%£12%AnExampleofaCurrencySwap20AnExampleofaCurrencySwap$8%£12%FirmBSwapBankFirmA£11%$8%$9.4%£12%Asaves£.6%A’snetpositionistoborrowat£11%AnExampleofaCurrencySwap$21AnExampleofaCurrencySwap

$8%FirmBSwapBankFirmA£11%$8%$9.4%

£12%B’snetpositionistoborrowat$9.4%Bsaves$.6%AnExampleofaCurrencySwap22AnExampleofaCurrencySwap

$8%£12%FirmBTheswapbankmakesmoneytoo:AtS0($/£)=$1.60/£,thatisagainof$124,000peryearfor5years.SwapBankFirmA£11%$8%$9.4%£12%1.4%of$16millionfinancedwith1%of£10millionperyearfor5years.Theswapbankfacesexchangeraterisk,butmaybetheycanlayitoff(inanotherswap).AnExampleofaCurrencySwap23TheQSDTheQualitySpreadDifferencerepresentsthepotentialgainsfromtheswapthatcanbesharedbetweenthecounterpartiesandtheswapbank.Thereisnoreasontopresumethatthegainswillbesharedequally.Intheaboveexample,companyBislesscredit-worthythanbankA,sotheyprobablywouldhavegottenlessoftheQSD,inordertocompensatetheswapbankforthedefaultrisk.TheQSDTheQualitySpreadDiff24ComparativeAdvantage

astheBasisforSwapsAhasacomparativeadvantageinborrowingindollars.Bhasacomparativeadvantageinborrowinginpounds.Aisthemorecredit-worthyofthetwofirms.Apays2%lesstoborrowindollarsthanBApays.4%lesstoborrowinpoundsthanB:ComparativeAdvantage

asthe25ComparativeAdvantage

astheBasisforSwapsBhasacomparativeadvantageinborrowingin£.Bpays2%moretoborrowindollarsthanABpaysonly.4%moretoborrowinpoundsthanA:ComparativeAdvantage

asthe26ComparativeAdvantage

astheBasisforSwapsAhasacomparativeadvantageinborrowingindollars.Bhasacomparativeadvantageinborrowinginpounds.Iftheyborrowaccordingtotheircomparativeadvantageandthenswap,therewillbegainsforbothparties.ComparativeAdvantage

asthe27SwapMarketQuotationsSwapbankswilltailorthetermsofinterestrateandcurrencyswapstocustomers’needsTheyalsomakeamarketin“plainvanilla”swapsandprovidequotesforthese.Sincetheswapbanksaredealersfortheseswaps,thereisabid-askspread.Forexample,6.60—6.85meanstheswapbankwillpayfixed-ratepaymentsat6.60%againstreceivingdollarLIBORoritwillreceivefixed-ratepaymentsat6.85%againstreceivingdollarLIBOR.SwapMarketQuotationsSwapban28VariationsofBasicCurrencyandInterestRateSwapsfixedforfixedfixedforfloatingfloatingforfloatingamortizingForaswaptobepossible,aQSDmustexist.Beyondthat,creativityistheonlylimit.VariationsofBasicCurrencya29RisksofInterestRate

andCurrencySwapsInterestRateRiskInterestratesmightmoveagainsttheswapbankafterithasonlygottenhalfofaswaponthebooks,orifithasanunhedgedposition.BasisRiskIfthefloatingratesofthetwocounterpartiesarenotpeggedtothesameindex.ExchangerateRiskIntheexampleofacurrencyswapgivenearlier,theswapbankwouldbeworseoffifthepoundappreciated.RisksofInterestRate

andCu30RisksofInterestRate

andCurrencySwaps(continued)CreditRiskThisisthemajorriskfacedbyaswapdealer—theriskthatacounterpartywilldefaultonitsendoftheswap.MismatchRiskIt’shardtofindacounterpartythatwantstoborrowtherightamountofmoneyfortherightamountoftime.SovereignRiskTheriskthatacountrywillimposeexchangeraterestrictionsthatwillinterferewithperformanceontheswap.RisksofInterestRate

andCu31PricingaSwapAswapisaderivativesecuritysoitcanbepricedintermsoftheunderlyingassets:Howto:Plainvanillafixedforfloatingswapgetsvaluedjustlikeabond.Currencyswapgetsvaluedjustlikeanestofcurrencyfutures.PricingaSwapAswapisaderi32SwapMarketEfficiencySwapsoffermarketcompletenessandthathasaccountedfortheirexistenceandgrowth.Swapsassistintailoringfinancingtothetypedesiredbyaparticularborrower.Sincenotalltypesofdebtinstrumentsareavailabletoalltypesofborrowers,bothcounterpartiescanbenefit(aswellastheswapdealer)throughfinancingthatismoresuitablefortheirassetmaturitystructures.SwapMarketEfficiencySwapsof33ConcludingRemarksThegrowthoftheswapmarkethasbeenastounding.Swapsareoff-the-bookstransactions.SwapshavebecomeanimportantsourceofrevenueandriskforbanksConcludingRemarksThegrowtho34ManagingFinancialRiskUnderstandthebasicdifferencebetweenhedgingandspeculatingDiscernbetweenthetypesofhedgingstrategiesusingfutures,options,swaps,andproductssuchasinterestrateceiling,floor,andcollarsDevelopappropriateinterestratehedgingstrategiesManagingFinancialRiskUnderst35FinancialRiskChangesininterestratesforeignexchangeratescommoditiespricesFinancialRiskChangesin36RiskProfile

Attitudetowardsriskforeachpotentialexposure.Risk-returntradeoff.Basisforfinancialriskmanagement.RiskProfile

Attitudetowards37ObjectivesofFinancialRiskManagementDetermineRiskProfileValueatRisk(VAR)SetBasicGoalsIdentifyandMeasuretheLevelofRiskExposureManageExposureMonitorExposureObjectivesofFinancialRiskM38Hedgingvs.SpeculatingAhedgerhasacashpositionorananticipatedcashpositionthatheorsheistryingtoprotectfromadverseinterestratemovementsAspeculatorhasnooperatingcashflowpositiontoprotectandistryingtoprofitsolelyfrominterestratemovementsHedgingvs.SpeculatingAhedge39SomeImportantTermsHedgerSpeculatorArbitragePerfectvsimperfecthedgePurevsanticipatoryhedgePartialandcrosshedgeLong(buy)andshort(sell)hedgeMarktomarketSomeImportantTermsHedger40HedgerEntitythatusesfinancialinstrumentstoreducethepricerisksassociatedwithhisbasicbusinessactivities.Byassumingapositioninthefuturesmarketthatisequalandoppositetothepositioninthecashmarket,thehedgerestablishedasituationwherelossesinthecashmarketareoffsetbygainsinthefuturesmarketandviceversa.HedgerEntitythatusesfinanci41SpeculatorAnentitywhotakesapositioninthefinancialmarketthatisnotoffsetbyanoppositepositioninabasiclineofbusiness.Aspeculator“bets”onthedirectionofthemarketandiswillingtoassumeriskSpeculatorAnentitywhotakes42ArbitrageProcessbywhichbuyinginonemarketandsellinginanotherLeadstoarisklessprofit.Arbitragersdonotassumerisk,butprofitfrommarketinefficienciesArbitrageProcessbywhichbuyi43PerfectvsImperfectHedgeAperfecthedgeisonewheretheindividualisabletoeliminateallriskofpricefluctuations.PerfectvsImperfectHedgeApe44PurevsAnticipatoryHedgeApurehedgeisonewheretheindividualassumesapositioninthefuturesmarketequalandoppositetothecurrentpositioninthecashmarket(suchashedgingaridingtheyieldcurveposition).Ananticipatoryhedgeistakingapositionthatisatemporarysubstituteforananticipatedpositioninthecashmarket.PurevsAnticipatoryHedgeApu45PartialandCrossHedgeApartialhedgeiswherethepersontakesapositioninthefuturesmarketthatissmallerthanthecashposition.Acrosshedgeiswherethemanagerusesadifferenthedginginstrument(futuresinstrument)thanthehedgedcashinstrument.PartialandCrossHedgeAparti46Long(buy)andShort(sell)HedgeAlonghedgeiswherethefirmBUYSafuturescontract.AshorthedgeiswherethefirmSELLSafuturescontract.Alonghedgeisappropriatewhenthefirmwillbuyanassetinthefutureorsellaliabilitypriortomaturity.Ashorthedgeisappropriatewhenthefirmissuesaliabilityinthefutureorsellsacurrentcashpositioninthefuture.Long(buy)andShort(sell)He47MarktoMarketEverydaythegainorlossonafuturespositioncausesyourmarginaccounttobeadjusted,gainsorcreditedtoyouraccountandlossesordebitedMarktoMarketEverydaythegai48Buyvs.SellHedgeTypeofhedgeshoulddependonthenatureofthecashflowpositionbeinghedged,notontheanticipateddirectionofinterestrates.BuyHedge:AfutureinvestmentorretiringaliabilitypriortomaturitySellHedge:IssuealiabilityinthefutureorsellaninvestmentpriortoitsmaturityBuyvs.SellHedgeTypeofhedg49WhyHedgesAreNotPerfectFuturescontractingeneralhaveonlyfourexpirationdatesperyear.(NoteT-bills:Mar,June,Sept,andDec.

Correlationcoefficientofspotratesandfuturesratesislessthan1.0WhyHedgesAreNotPerfectFutu50OtherHedgingInstrumentsInterestratecapsPurchaserpaysapremiumandreceivescashpaymentsfromthecapsellerwhenthereferencerateexceedsstrikerate.InterestratefloorsPurchaserpaysapremiumfortheratefloorcontract,receivescashpaymentwhenreferenceratefallsbelowstrikerate.InterestratecollarsPurchasearatecapandsellorissuearatefloor.Payapremiumforthecapandreceiveapremiumforthefloor.

OtherHedgingInstrumentsInter51TypesofForeignExchangeExposure

TransactionExposureTranslationExposureEconomicExposureTypesofForeignExchangeExpo52ForeignExchangeMarketsSpotMarketandtheSpotForeignExchangeRateForwardMarketandtheForwardExchangeRateForwardExchangeRateandInterestRateParityForeignExchangeMarketsSpotM53TypeofFXContracts

ForwardsFuturesCurrencySwapsOptionsTypeofFXContracts

Forwards54swapCurrency&InterestRateswapCurrency&InterestRate55Currency&InterestRateSwaps

Thischapterdiscussescurrencyandinterestrateswaps,whicharerelativelynewinstrumentsforhedginglong-terminterestrateriskandforeignexchangerisk.Currency&InterestRateSwaps56OutlineTypesofSwapsSizeoftheSwapMarketTheSwapBankInterestRateSwapsCurrencySwapsOutlineTypesofSwaps57Outline(continued)SwapMarketQuotationsVariationsofBasicCurrencyandInterestRateSwapsRisksofInterestRateandCurrencySwapsSwapMarketEfficiencyConcludingPointsAboutSwapsOutline(continued)SwapMarket58DefinitionsInaswap,twocounterpartiesagreetoacontractualarrangementwhereintheyagreetoexchangecashflowsatperiodicintervals.Therearetwotypesofinterestrateswaps:Singlecurrencyinterestrateswap“Plainvanilla”fixed-for-floatingswapsareoftenjustcalledinterestrateswaps.Cross-CurrencyinterestrateswapThisisoftencalledacurrencyswap;fixedforfixedratedebtserviceintwo(ormore)currencies.DefinitionsInaswap,twocoun59SizeoftheSwapMarketIn2001thenotationalprincipalof:Interestrateswapswas$58,897,000,000.Currencyswapswas$3,942,000,000Themostpopularcurrenciesare:U.S.dollarJapaneseyenEuroSwissfrancBritishpoundsterlingSizeoftheSwapMarketIn200160TheSwapBankAswapbankisagenerictermtodescribeafinancialinstitutionthatfacilitatesswapsbetweencounterparties.Theswapbankcanserveaseitherabrokeroradealer.Asabroker,theswapbankmatchescounterpartiesbutdoesnotassumeanyoftherisksoftheswap.Asadealer,theswapbankstandsreadytoaccepteithersideofacurrencyswap,andthenlaterlayofftheirrisk,ormatchitwithacounterparty.TheSwapBankAswapbankisa61AnExampleofanInterestRateSwapConsiderthisexampleofa“plainvanilla”interestrateswap.BankAisaAAA-ratedinternationalbanklocatedintheU.K.andwishestoraise$10,000,000tofinancefloating-rateEurodollarloans.BankAisconsideringissuing5-yearfixed-rateEurodollarbondsat10percent.Itwouldmakemoresenseforthebanktoissuefloating-ratenotesatLIBORtofinancefloating-rateEurodollarloans.AnExampleofanInterestRate62AnExampleofanInterestRateSwapFirmBisaBBB-ratedU.S.company.Itneeds$10,000,000tofinanceaninvestmentwithafive-yeareconomiclife.FirmBisconsideringissuing5-yearfixed-rateEurodollarbondsat11.75percent.Alternatively,firmBcanraisethemoneybyissuing5-yearfloating-ratenotesatLIBOR+½percent.FirmBwouldprefertoborrowatafixedrate.AnExampleofanInterestRate63AnExampleofanInterestRateSwapTheborrowingopportunitiesofthetwofirmsare:AnExampleofanInterestRate64AnExampleofanInterestRateSwapTheswapbankmakesthisoffertoBankA:YoupayLIBOR–1/8%peryearon$10millionfor5yearsandwewillpayyou103/8%on$10millionfor5yearsSwapBankLIBOR–1/8%103/8%BankAAnExampleofanInterestRate65AnExampleofanInterestRateSwapHere’swhat’sinitforBankA:Theycanborrowexternallyat10%fixedandhaveanetborrowingpositionof-103/8+10+(LIBOR–1/8)=LIBOR–½%whichis½%betterthantheycanborrowfloatingwithoutaswap.10%½%of$10,000,000=$50,000.That’squiteacostsavingsperyearfor5years.SwapBankLIBOR–1/8%103/8%BankAAnExampleofanInterestRate66AnExampleofanInterestRateSwapTheswapbankmakesthisoffertocompanyB:Youpayus10½%peryearon$10millionfor5yearsandwewillpayyouLIBOR–¼%peryearon$10millionfor5years.CompanyBSwapBank10½%LIBOR–¼%AnExampleofanInterestRate67AnExampleofanInterestRateSwapAnExampleofanInterestRateSwap:TheycanborrowexternallyatLIBOR+½%andhaveanetborrowingpositionof10½+(LIBOR+½)-(LIBOR-¼)=11.25%whichis½%betterthantheycanborrowfloating.

LIBOR+½%½%of$10,000,000=$50,000that’squiteacostsavingsperyearfor5years.SwapBankCompanyB10½%LIBOR–¼%AnExampleofanInterestRate68AnExampleofanInterestRateSwap

Theswapbankmakesmoneytoo.LIBOR–1/8–[LIBOR–¼]=1/810½-103/8=1/8¼SwapBankCompanyB10½%LIBOR–¼%LIBOR–1/8%103/8%BankAAnExampleofanInterestRate69AnExampleofanInterestRateSwap

Theswapbankmakes¼%SwapBankCompanyB10½%LIBOR–¼%LIBOR–1/8%103/8%BankABsaves½%Asaves½%AnExampleofanInterestRate70AnExampleofaCurrencySwapSupposeaU.S.MNCwantstofinancea£10,000,000expansionofaBritishplant.TheycouldborrowdollarsintheU.S.wheretheyarewellknownandexchangefordollarsforpounds.Thiswillgivethemexchangeraterisk:financingasterlingprojectwithdollars.Theycouldborrowpoundsintheinternationalbondmarket,butpayapremiumsincetheyarenotaswellknownabroad.AnExampleofaCurrencySwapS71AnExampleofaCurrencySwapIftheycanfindaBritishMNCwithamirror-imagefinancingneedtheymaybothbenefitfromaswap.IfthespotexchangerateisS0($/£)=$1.60/£,theU.S.firmneedstofindaBritishfirmwantingtofinancedollarborrowingintheamountof$16,000,000.AnExampleofaCurrencySwapI72AnExampleofaCurrencySwapConsidertwofirmsAandB:firmAisaU.S.–basedmultinationalandfirmBisaU.K.–basedmultinational.Bothfirmswishtofinanceaprojectineachother’scountryofthesamesize.Theirborrowingopportunitiesaregiveninthetablebelow.AnExampleofaCurrencySwapC73AnExampleofaCurrencySwap

$9.4%FirmB$8%£12%SwapBankFirmA£11%$8%£12%AnExampleofaCurrencySwap74AnExampleofaCurrencySwap$8%£12%FirmBSwapBankFirmA£11%$8%$9.4%£12%Asaves£.6%A’snetpositionistoborrowat£11%AnExampleofaCurrencySwap$75AnExampleofaCurrencySwap

$8%FirmBSwapBankFirmA£11%$8%$9.4%

£12%B’snetpositionistoborrowat$9.4%Bsaves$.6%AnExampleofaCurrencySwap76AnExampleofaCurrencySwap

$8%£12%FirmBTheswapbankmakesmoneytoo:AtS0($/£)=$1.60/£,thatisagainof$124,000peryearfor5years.SwapBankFirmA£11%$8%$9.4%£12%1.4%of$16millionfinancedwith1%of£10millionperyearfor5years.Theswapbankfacesexchangeraterisk,butmaybetheycanlayitoff(inanotherswap).AnExampleofaCurrencySwap77TheQSDTheQualitySpreadDifferencerepresentsthepotentialgainsfromtheswapthatcanbesharedbetweenthecounterpartiesandtheswapbank.Thereisnoreasontopresumethatthegainswillbesharedequally.Intheaboveexample,companyBislesscredit-worthythanbankA,sotheyprobablywouldhavegottenlessoftheQSD,inordertocompensatetheswapbankforthedefaultrisk.TheQSDTheQualitySpreadDiff78ComparativeAdvantage

astheBasisforSwapsAhasacomparativeadvantageinborrowingindollars.Bhasacomparativeadvantageinborrowinginpounds.Aisthemorecredit-worthyofthetwofirms.Apays2%lesstoborrowindollarsthanBApays.4%lesstoborrowinpoundsthanB:ComparativeAdvantage

asthe79ComparativeAdvantage

astheBasisforSwapsBhasacomparativeadvantageinborrowingin£.Bpays2%moretoborrowindollarsthanABpaysonly.4%moretoborrowinpoundsthanA:ComparativeAdvantage

asthe80ComparativeAdvantage

astheBasisforSwapsAhasacomparativeadvantageinborrowingindollars.Bhasacomparativeadvantageinborrowinginpounds.Iftheyborrowaccordingtotheircomparativeadvantageandthenswap,therewillbegainsforbothparties.ComparativeAdvantage

asthe81SwapMarketQuotationsSwapbankswilltailorthetermsofinterestrateandcurrencyswapstocustomers’needsTheyalsomakeamarketin“plainvanilla”swapsandprovidequotesforthese.Sincetheswapbanksaredealersfortheseswaps,thereisabid-askspread.Forexample,6.60—6.85meanstheswapbankwillpayfixed-ratepaymentsat6.60%againstreceivingdollarLIBORoritwillreceivefixed-ratepaymentsat6.85%againstreceivingdollarLIBOR.SwapMarketQuotationsSwapban82VariationsofBasicCurrencyandInterestRateSwapsfixedforfixedfixedforfloatingfloatingforfloatingamortizingForaswaptobepossible,aQSDmustexist.Beyondthat,creativityistheonlylimit.VariationsofBasicCurrencya83RisksofInterestRate

andCurrencySwapsInterestRateRiskInterestratesmightmoveagainsttheswapbankafterithasonlygottenhalfofaswaponthebooks,orifithasanunhedgedposition.BasisRiskIfthefloatingratesofthetwocounterpartiesarenotpeggedtothesameindex.ExchangerateRiskIntheexampleofacurrencyswapgivenearlier,theswapbankwouldbeworseoffifthepoundappreciated.RisksofInterestRate

andCu84RisksofInterestRate

andCurrencySwaps(continued)CreditRiskThisisthemajorriskfacedbyaswapdealer—theriskthatacounterpartywilldefaultonitsendoftheswap.MismatchRiskIt’shardtofindacounterpartythatwantstoborrowtherightamountofmoneyfortherightamountoftime.SovereignRiskTheriskthatacountrywillimposeexchangeraterestrictionsthatwillinterferewithperformanceontheswap.RisksofInterestRate

andCu85PricingaSwapAswapisaderivativesecuritysoitcanbepricedintermsoftheunderlyingassets:Howto:Plainvanillafixedforfloatingswapgetsvaluedjustlikeabond.Currencyswapgetsvaluedjustlikeanestofcurrencyfutures.PricingaSwapAswapisaderi86SwapMarketEfficiencySwapsoffermarketcompletenessandthathasaccountedfortheirexistenceandgrowth.Swapsassistintailoringfinancingtothetypedesiredbyaparticularborrower.Sincenotalltypesofdebtinstrumentsareavailabletoalltypesofborrowers,bothcounterpartiescanbenefit(aswellastheswapdealer)throughfinancingthatismoresuitablefortheirassetmaturitystructures.SwapMarketEfficiencySwapsof87ConcludingRemarksThegrowthoftheswapmarkethasbeenastounding.Swapsareoff-the-bookstransactions.SwapshavebecomeanimportantsourceofrevenueandriskforbanksConcludingRemarksThegrowtho88ManagingFinancialRiskUnderstandthebasicdifferencebetweenhedgingandspeculatingDiscernbetweenthetypesofhedgingstrategiesusingfutures,options,swaps,andproductssuchasinterestrateceiling,floor,andcollarsDevelopappropriateinterestratehedgingstrategiesManagingFinancialRiskUnderst89FinancialRiskChangesininterestratesforeignexchangeratescommoditiespricesFinancialRiskChangesin90RiskProfile

Attitudetowardsriskforeachpotentialexposure.Risk-returntradeoff.Basisforfinancialriskmanagement.RiskProfile

Attitudetowards91ObjectivesofFinancialRiskManagementDetermineRiskProfileValueatRisk(VAR)SetBasicGoalsIdentifyandMeasuretheLevelofRiskExposureManageExposureMonitorExposureObjectivesofFinancialRiskM92Hedgingvs.SpeculatingAhedgerhasacashpositionorananticipatedcashposit