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Swaps

Swaps are private agreements between two parties to exchange cash flows according to a pre-arranged formula. The cash flows can be fixed or variable, determined by an uncertain variable like interest or currency exchange rates. The main types of swaps are interest rate swaps, currency swaps, commodity swaps, and equity swaps. Interest rate swaps exchange fixed and floating interest rate loans to hedge against rising or falling rates. Currency swaps exchange interest payments and principal denominated in different currencies to hedge currency risk or obtain better foreign loan rates. Commodity and equity swaps similarly exchange variable cash flows tied to commodity prices or stock returns for fixed rates.

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322 views

Swaps

Swaps are private agreements between two parties to exchange cash flows according to a pre-arranged formula. The cash flows can be fixed or variable, determined by an uncertain variable like interest or currency exchange rates. The main types of swaps are interest rate swaps, currency swaps, commodity swaps, and equity swaps. Interest rate swaps exchange fixed and floating interest rate loans to hedge against rising or falling rates. Currency swaps exchange interest payments and principal denominated in different currencies to hedge currency risk or obtain better foreign loan rates. Commodity and equity swaps similarly exchange variable cash flows tied to commodity prices or stock returns for fixed rates.

Uploaded by

Jaythumer
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Swaps

• Swaps are private agreement between two parties to exchange one stream
of future cash flow for an other stream of cash flow in accordance with a
pre arranged formula.

• The agreement provides details of how the cash flows will be calculated
and the dates on which the cash flows will be exchanged.

• In contract at least one of these cash flows will be determined on the basis
of an uncertain variable, while other could either be fixed or be determined
on the basis of another uncertain variable.

• Swaps contracts are private, OTC agreements, and no exchange exists for
swap contracts.
Types of swaps

Interest Rate Swaps

Currency Swaps

Commodity Swaps

Equity Swaps
Interest Rate Swaps
In interest rate swap, a fixed interest rate loan is exchanged for
a floating interest rate loan.
Hedging strategies with interest rate
swaps

NATURE RISK HEADGING ACTION


Assets(i.e. deposit)
Fixed rate Rising interest rates Swap from fixed rate to
floating rate
Floating rate Falling interest rates Swap from floating rate to
fixed rate
Liabilities(i.e. Borrowing)
Fixed rate Falling interest rates Swap from fixed rate to
floating rate
Floating rate Rising interest rates Swap from floating rate to
fixed rate
What is a Currency Swap
Contract?
A currency swap contract (also known as a cross-
currency swap contract) is a derivative contract
between two parties that involves the exchange of
interest payments, as well as the exchange
of principal amount in certain cases, that are
denominated in different currencies. Although
currency swap contracts generally imply the
exchange of principals, some swaps may require
only the transfer of the interest payments.
• A currency swap consists of two streams (legs) of fixed or
floating interest payments denominated in two different
currencies. The transfers of interest payments occur on
predetermined dates. In addition, if the swap counterparties
previously agreed to exchange principal amounts, the amounts
must also be exchanged on the maturity date at the
same exchange rate.

• Currency swaps are primarily used to hedge potential risks


associated with fluctuations in currency exchange rates or to
obtain lower interest rates on loans in foreign currency. The
swaps are commonly used by companies that operate in different
countries.

• For example, a company may take a loan in domestic currency


and enter a swap contract with a foreign company to obtain a
more favourable interest rate on the foreign currency that is
otherwise is unavailable.
How it works?
Types of Currency Swap Contracts
Similar to the interest rate swaps, currency swaps can
be classified based on the types of leg involved in a
contract. The most commonly encountered types of
currency swaps include the following:

• Fixed vs. float: One leg of currency swap represents


a stream of fixed interest payments while another leg
is a stream of floating interest payments.
• Float vs. float (basis swap): The float vs. float swap
is commonly referred to as basis swap. In a basis
swap, both swaps’ legs represent floating interest
payments.
• Fixed vs. fixed: Both streams of currency swap
contracts involve fixed interest rate payments.
Equity Swaps
 An equity swap is a process in which two cash
flows are exchanged between two parties, of which
one represents the returns on a stock or stock
index.
 The other leg of the swap represents cash flow
from a moving money market index or a fixed rate.
However, this is not the only case.
 An equity swap may also be conducted when both
cash flows are from a stock.
 Equity swap is an exchange of future cash flows
between parties
 equity swap is similar to an interest rate swap.

Most equity swaps are shown between large


financing firms.
Commodity Swaps
 Commodity swaps are designed to wind break the risk
with the prices of input resource.

 Commodity swaps are common between individuals


or companies that use raw materials to produce goods.

 A commodity swap allows receipt of payment linked


to the commodity price against a fixed rate.

 The performance of the swaps is realte with


performance of asset.

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