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Submitted to: Sir Imtiaz askari
By: MUHAMMED NISAR(3105)
TARIQ ANIS(3234)
Risk Management
Definition: In a swap, two counterparties agree to exchange
or swap cash flows at periodic intervals.
Nature of Swaps: A swap is an agreement to exchange cash flows at
specified future times according to certain specified rules
There are two types of swaps:Interest rate swap Currency swap
SWAPS
Definition:An exchange of fixed-rate interest payments for
floating-rate interest payments. Reason: One party actually wants fixed rate debt, but can get a better deal on floating rate; the other party wants floating rate debt, but can get a better deal on fixed rate. Both parties can gain by swapping loan payments, usually through a bank as a financial intermediary (FI), which charges a fee to broker the transaction.
Interest Rate Swap
SWAP BANK o Broker bank
Arranges the deals but does not assume any of the risk
Charges a commission/fee for structuring and servicing the swap.
o Dealer bank Dealer willing to take a position in one side, therefore
assume some risk Dealer would not only receive a commission for arranging
the swap Take a position in the swap
MARKET MAKER
Typical Uses of an Interest Rate Swap
Converting a liability from
fixed rate to floating rate
floating rate to fixed rate
Converting an investment from
fixed rate to floating rate
floating rate to fixed rate
Swaps
FINANCIAL INSTITUTION
SWAP MARKET MAKERMaturity Bid (%) Offer (%) Swap Rate (%)
2 years 6.03 6.06 6.045
3 years 6.21 6.24 6.225
4 years 6.35 6.39 6.370
5 years 6.47 6.51 6.490
7 years 6.65 6.68 6.665
10 years 6.83 6.87 6.850
Swaps concerns comparative advantages, use of interest rate swap to transform a liability
Co. argued they have an when borrowing in fixed rate, whereas other companies have a comparative advantage in the floating rate
Company may borrow fixed when it wants floating or borrow floating when it wants fixed
The swap is used to transform a fixed rate loan into floating rate loan and vice versa.
COMPARATIVE ADVANTAGE ARGUMENT
Definition:An exchange of interest payments in one
currency for interest payments in another currency.
One party swaps the interest payments of debt (bonds) denominated in one currency (USD) for the interest payment of debt (bonds) denominated in another currency (SF or BP), usually on a "fixed-for-fixed rate" basis. Currency swap is used for cost savings on debt, or for hedging long term currency risk.
Currency swap
General Electric wants to borrow POUNDQantas wants to borrow USD
COMPARATIVE ADVANTAGE ARGUMENTS FOR CURRENCY SWAPS
FINANCIAL INSTITUTION
Interest Rate Swap:In an interest rate swap the
principal is not exchanged
Currency Swap:In a currency swap the principal is
usually exchanged at the beginning and the end of the swap’s life
EXCHANGE OF PRINCIPAL
Thank You