Managing Interest Rate
Risk with Cross Currency
Swaps
Saniye Atak
Chintan Shah
Eddie Warner
NYU-SCPS. Interest Rate Swaps. X51.9204
26 July 2010
Some Tools to Manage Interest
Rate Risk
Refinancing go back to lender and
restructure/refinance the agreement. Not
always possible and usually expensive.
Forward Rate Agreement lock in future
interest rate payment. OTC market.
Interest Rate Futures lock in future
interest rate payments by taking a position in
an interest rate futures position.
Interest Rate Swaps enter into an
agreement with a bank or swap-dealer to
exchange cash flows in such a way that
interest rate payments on a floating loan
would become fixed.
Cross Currency Swaps
An agreement between two counterparties
to exchange future cash flows.
Cross Currency Swap involves the exchange of
cash flows from one currency for those in
another with an agreement to reverse that
transaction at a future date.
Interest Rate swaps changes the basis on
which income streams or liabilities are
received or paid on a specified principal
amount.
Cross Currency Swaps
Two cash-flow schedules in different
currencies.
Two notional amounts in different currencies.
Motivation to enter in a cross currency swap is
the desire to pay interest in a currency with
lower rates such as JPY or CHF and receive
interest in a currency with higher rates.
Gives companies extra flexibility to exploit
their comparative advantage in their
respective borrowing markets.
Allows companies to explain advantages
across a matrix of currencies and maturities.
Cross Currency Swaps
Advantages
Beneficial interest rate payments, i.e. receiving
higher coupons or paying lower coupons than
market
Liquid and transparent product
Zero/Low cost product
(Partial) protection of the notional possible
Disadvantages
Long term FX forward risk
Long term view on the FX rate impossible
Structure of a Cross
Currency Swap
Exchange notional amounts at inception
Use current spot rate (CHF = Swiss Francs)
$10m USD at 1.1138 CHF, Sfr 11.138m
Pay/Receive intermediate cash flows
Use bid/ask swap rates
Re-exchange notional amounts at expiration
Using agreed upon spot rate, 1.1138 CHF
CHF stands for Confoederatio Helvetica
Franc
Initial Exchange of Notional
Pay/Receive Intermediate Cash
Flows
Re-exchange notional at
expiration
Cross Currency Swap Case
Study
Carlton Corporation
Recently took out a 3Y floating-rate loan for
$10M
Was worried interest rates would rise
Used an Interest Rate Swap to convert to fixed
Carlton recently signed a contract with a
Swiss buyer that will be paying Francs to
Carlton
Incoming Swiss Francs cash flows
Good motivation for Cross Currency Swap
Interest Rate and Currency Swap
Quotes
Years
1
2
3
4
5
6
7
8
9
10
12
15
20
25
30
LIBOR
Euro -
Bid
Ask
2.99
3.02
3.08
3.12
3.24
3.28
3.44
3.48
3.63
3.67
3.83
3.87
4.01
4.05
4.18
4.22
4.32
4.36
4.42
4.46
4.58
4.62
4.75
4.82
5.00
5.04
5.13
5.17
5.19
5.23
3.0313
3.0938
Swiss Franc - Sfr
Bid
Ask
1.43
1.47
1.68
1.76
1.93
2.01
2.15
2.23
2.35
2.43
2.54
2.62
2.73
2.81
2.91
2.99
3.08
3.16
3.22
3.30
3.45
3.55
3.71
3.81
3.96
4.06
4.07
1.17
4.16
4.26
1.3125
1.4375
US Dollar $
Bid
Ask
5.24
5.27
5.43
5.46
5.56
5.59
5.65
5.68
5.73
5.76
5.80
5.83
5.86
5.89
5.92
5.95
5.96
5.99
6.01
6.04
6.10
6.13
6.20
6.23
6.29
6.32
6.29
6.32
6.28
6.31
4.9373
5.0625
Japanese
Bid
0.23
0.36
0.56
0.82
1.09
1.33
1.55
1.75
1.90
2.04
2.28
2.51
2.71
2.77
2.82
Yen -
Ask
0.26
0.39
0.59
0.85
1.12
1.36
1.58
1.78
1.93
2.07
2.32
2.56
2.76
2.82
2.88
0.1250
0.2188
Setting up the Cross Currency
Swap
Carlton enters into a three-year receive
US Dollars and pay Swiss francs.
Carlton pays 3Y CHF Ask rate (2.01%)
Carlton receives 3Y USD Bid rate (5.56%)
Target currency is CHF. $10M = 11.138M
Sfr
Interest Payment: 2.01% 11.138M Sfr =
223,873.80 Sfr
Receiving currency is USD.
Interest Received: 5.56% 10M = $556,000
Pay CHF & Receive USD
Accounting practices will require mark-to-market
If CHF appreciates, Carlton would record a loss.
If CHF interest rates were rising, Carlton
committed to a fixed 2.01% and would record a
gain.
P&L will persist over course of swaps life.
How to price a currency swap
swap with SWPM
SWPM is the main interest rate derivatives pricing function
in the Bloomberg professional system, allowing users to
price a wide range of vanilla and exotic interest rate swaps,
interest rate options, swaptions and interest rate / hybrid
structured notes.
We will use SWPM to price a cross currency interest rate
swap transaction and calculate a mark to market price with
current markets or historicized curves.
Example
Receive 4.5% on 10MM USD and pay floating
Euribor 3M
To have a quick price of a new Interest Rate Swap transaction user has to
- open SWPM;
- enter the IRS details in the Main Screen relevant input fields;
- select Calculate Premium from Calculate menu field;
- refresh for price
In Curves Screen user can:
- visualize and export in Excel the par or zero coupon curve used for swap
evaluation;
- manually override curve values;
- apply shifts to the whole curve or to defined buckets;
- choose interpolation method used;
Use the Cashflow Screen to visualize and export to an Excel spreadsheet deal
cash
flows, with the ability to choose between Net, Pay, Receive and Historical cash
flows.
The Risk Screen shows for each leg some key risk measures :
- DV01: the dollar value of a 1-basis-point negative shift in the curve.
- Risk: the risk for each leg and the deal is calculated according to the
following
equations:
Risk = [DV01 / Notional] x 10,000
