Swaps

Financing: fixed and variable rates.The role of swap contracts.

19 Novembro 2013

Presentation by:

• Paulo Martins 65929 METI

• António Junior 57699

METI

• Vilma Jordão 59056 MEIC

• António Alves 65872

MEIC

Swaps

• Has Grown alot in the past 20 years

• Protection from financial risks

• Balancing operational costs

• Financing in moments of low market liquidity

Swap Dealer

• Swap contracts aren’t made with well defined rules.

• There is always some entity in the midle called Swap Dealer.

Types of Swaps

• Interest Rate Swaps

• Currency Swaps

• Comodity Swaps

• Credit Default Swaps

• Equity Swaps

Interest Rate Swaps

• In this kind of swap there is an exchange between fixed and variable interest rates.

• It implies a great risk and results in great losses for one of the parts.

• One of the parts pays the difference between the fixed and the variable interest rate.

Interest Rate Swaps - Example

Two entities (α and β) need funding.

• α wishes to get financed with a variable interest rate.

• β wishes to get financed with a fixes interest rate.


Fixed rates Variable rates

Company α 6% Euribor 3 months + 1.25%

Company β 7% Euribor 3 months + 1.50%

α gets a loan of 10 m€, at a fixed rate of 6%, for 10 years;

β gets a loan of 10 m€, at the variable rate Euribor 3 months + 1.5%, for 10 years.

Rates offered to company α and β


1. α will have a loan at a variable rate, as wished, with a rate of: Euribor 3months + (6%-5.25%) = Euribor 3month + 0.75%

2. β will have a loan at a fixed rate, with a rate of: 5.25%+(Euribor 3months+1.5%)-Euribor 3 months = 6.75%


If α had a loan at a variable rate, it would pay Euribor 3months + 1.25%, meaning a profit of 0.5%;If β had a loan at a fixed rate, it would pay 7%, meaning a profit of 0.25%.

Taxa Valor Juro

Empresa α 4.5% € 450 000

Empresa β 5.25% € 525 000

Currency Swaps

This kind of swap consists on the deal between two

entities, in the exchange for the obligations of a loan in

one currency for another loan obligations of equal net

value in another currency.

Currency Swaps - Types

• FX-Swaps

• Back-to-back

• Cross currency swaps

Currency Swaps - Example

1M

1.4M

Currency Swaps - Example

Commodity Swaps

The buyer and the seller both accept to exchange periodic payments, one with a fixed value and the other with a variable value, calculated over a predeterminated commodity amount

Commodity Swaps – Advantages and Goals

• Allow to establish a limit to the volatility of the commodity prices

• This way the raw material price stays immune to the market price flutuations

Commodity Swaps - Example

Credit Default Swaps

CDS Seller CDS Buyer



CDS Seller CDS Buyer

-1.000.000€+49.200€ x 3+1,049.200€

-38.600€ x 4

42.900€

1.000.000€ - Valor actual das obrigações

Equity Swaps

In an equity swap, two parties agree to exchange a set of future cash flows periodically for a specified period of time.

Equity Swaps - Example

• Notional Principal: $100 million• Alpha Fund pays: Total returns on the S&P 500

Index• Goldman Sachs pays: Fixed 6%• Swap maturity: 3 years• Payments to be made at the end of every six

months, that is, 30th June and 31st December

Equity Swaps - Example

Alpha Pays Goldman Pays

30th June

Return on index = 2600/2500 = 4% = 100,000,000*0.04 = $4,000,000

=100,000,000 * 182/365 * 6% =$2,991,780

31st December

Return on index = 2570/2600 = -1.154% Alpha pays nothing.

Fixed payment=100,000,000 * 183/365 * 6%=$3,008,219 Floating payment= 100,000,000*0.01154= $1,154,000 Total payment= $3,008,219+$1,154,000=$4,162,219

Let’s see how the cash flows turn out in the first year.At the beginning, the S&P Total Return Index was at 2500 level, on 30th June it was 2600, and on 31st December it was at 2570.

Thank You Questions?

Economy & Finance

Swaps