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    6 - Swap

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    nishant
    Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. There are two main types of swaps: interest rate swaps and currency swaps. Interest rate swaps involve the exchange of interest rate cash flows, such as fixed for floating, while currency swaps exchange principal and interest payments in one currency for the other. Companies enter into swaps to take advantage of comparative advantages in borrowing costs in different interest rate or currency environments.

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    6 - Swap

    Uploaded by

    nishant
    32 views29 pages
    Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. There are two main types of swaps: interest rate swaps and currency swaps. Interest rate swaps involve the exchange of interest rate cash flows, such as fixed for floating, while currency swaps exchange principal and interest payments in one currency for the other. Companies enter into swaps to take advantage of comparative advantages in borrowing costs in different interest rate or currency environments.

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    PPT 6 - SWAP

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    Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. There are two main types of swaps: interest rate swaps and currency swaps. Interest rate swaps involve the exchange of interest rate cash flows, such as fixed for floating, while currency swaps exchange principal and interest payments in one currency for the other. Companies enter into swaps to take advantage of comparative advantages in borrowing costs in different interest rate or currency environments.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    32 views29 pages

    6 - Swap

    Uploaded by

    nishant
    Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. There are two main types of swaps: interest rate swaps and currency swaps. Interest rate swaps involve the exchange of interest rate cash flows, such as fixed for floating, while currency swaps exchange principal and interest payments in one currency for the other. Companies enter into swaps to take advantage of comparative advantages in borrowing costs in different interest rate or currency environments.

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    Swaps

    Swaps

    • Swaps are private agreements between two parties to exchange cash


    flows in the future according to a prearranged formula.
    • There are two type of swaps.

    1. Interest rate swaps


    2. Currency swaps
    Interest rate swaps

    Interest rate swaps = A swap is a derivative in which


    two counterparties exchange cash flows of one party's financial instrument for
    those of the other party's financial instrument or we can say a company agree to
    pay cash flow equal to interest at a predetermined rate on a notional principal for a
    number of years in return it receive interest on the same notional principal for same
    number of years
    Interest rate swaps

    Swaps were first introduced to the public in 1981 when IBM and the World


    Bank entered into a swap agreement.
    Today, the total amount of interest rates and currency swaps outstanding is
    more than $348 trillion in 2010.
    Interest rate swaps

    There are three type of Interest rate swaps.


    1. Fixed vs fixed
    2. Fixed vs floating
    3. Floating vs fixed
    Fixed vs fixed

    Fixed vs fixed = Both Parties will exchange fixed


    interest cash flow.
    Fixed vs floating

    Fixed vs floating = First Parties will pay fixed interest


    cash flow and receive floating interest rate cash flow and
    vice - versa.
    Floating vs fixed

    Fixed vs floating = First Parties will pay floating interest


    cash flow and receive interest rate cash flow and vice -
    versa.
    Sir , can you tell me. Why we do
    swap??????
    First reason

    A is currently paying floating, but wants to pay fixed. B is


    currently paying fixed but wants to pay floating. By
    entering into an interest rate swap, the net result is that
    each party can 'swap' their existing obligation for their
    desired obligation.
    Second reason

    The second reason for this exchange is to take benefit


    from comparative advantage.
    Sir, What is
    comparative advantage.
    Comparative advantage

    Suppose two companies A and B wish to borrow 10 lakh


    for 5 years.
    company fixed Duration floating

    A 4% 5 yr LIBOR – .1%

    B 5.2% 5 yr LIBOR + .6%


    Comparative advantage

    Company A have comparative advantage in fixed but want


    to borrow floating.
    Company B have comparative advantage in floating but
    want to pay fixed.
    Comparative advantage

    Company A and B can enter into a swap to take the benefit


    of swap and change interest cash flows.
    How????
    Comparative advantage

    Company A
    Take loan @ 4% fixed interest rate.
    Company B
    Take loan @ LIBOR + .6%
    enter into a swap contract
    A will pay to B LIBOR and B will pay to A @ 4.35%
    fixed interest rate
    Comparative advantage

    Company A
    Net effect of company A will pay LIBOR - .35% (profit
    from B 4 - 4.35%)
    which is better then market.
    Company B
    Net effect of company B will pay 4.35% + .6% = 4.95%
    (loss from A( LIBOR – (LIBOR - .6%))) which is better
    then market.
    Currency swaps

    • A currency swap involves exchanging principal and


    interest payments on a loan in one currency for
    principal and interest payments on an equal loan in
    another currency.
    Reason for currency swap is……

     Comparative advantage.
    Comparative advantage

    Suppose two companies A (US)and B (IND) wish to


    borrow $1 lakh and 50 lakh for 5 years(1$ = 50 rupee).
    But company A want money in IND and company B in US

    company US Duration IND

    A 5% 5 yr 7.6%

    B 7% 5 yr 8.0%
    Comparative advantage

    Company A have comparative advantage in US.

    Company B have comparative advantage in IND.


    Comparative advantage

    Company A and B can enter into a swap to take the benefit


    comparative advantage.
    How????
    Comparative advantage

    Company A
    Take loan @ 5% fixed interest rate in US.
    Company B
    Take loan @ 8% fixed interest rate in IND
    enter into a swap contract
    A will give loan to B in US @ 5% and B will give same
    amount in IND to A @ 6.9%.
    Comparative advantage

    Company A
    Net effect of company A will get loan in IND @ 6.9%
    which is .7% better then market.
    Company B
    Net effect of company B will get loan in US @ 5 + 1.1%
    ( 8% – 6.9% ) = 6.1%
    which is .9% better then market.
    Last
    point
    Generally all type of swap is
    done through financial institution
    and charge small commission.
    THANK
    YOU
    VERY
    MUCH
    That’s all for the DAY!!!

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