Documente Academic
Documente Profesional
Documente Cultură
Charulata Sangwan
Deepak Garg
Himanshu Masurkar
Luis Mundra
Monika Bhagwani
INTRODUCTION:
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DEFINITION:
Bank UK commits to pay Bank US, over a period of 2 years, a stream of interest on
USD 14 million, the interest rate is agreed when the swap is negotiated; in
exchange, Bank US commits to pay Bank UK, over the same period, a counter
stream of sterling interest on GBP 10 million; this interest rate is also agreed when
the swap is negotiated. Bank UK and Bank US also commit to exchange, at the end
of the two year period, the principals of USD 14 million and GBP 10 million on
which interest payments are being made; the exchange rate of 1.4000 is agreed at
the start of the swap.
We can now see from the above that currency swaps differ from interest rate swaps
in that currency swaps involve:
If in the above-mentioned swap, the two banks agree to exchange the principal at the
beginning.
These swaps involve payments attached to a floating rate index for both the
currencies. In other words, floating-against-floating cross-currency basis swaps.
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Stages:
a. At the start of the swap, the GBP/USD rate is agreed at which the principal
amounts will be exchanged at maturity (probably, the prevailing GBP/USD spot
rate)
b. At the same time, interest rates for use in the swap are also agreed
c. Over the life of the swap, the UK Company will pay a stream of sterling
floating interest through the swap and will receive a counter stream of dollar fixed
interest in exchange. The dollar interest received through the swap will be used to
service the dollar borrowing; the sterling interest paid through the swap will be
funded from earnings.
d. At maturity, the company will pay a sterling principal amount through the
swap and receive a dollar principal amount in exchange. The exchange is made at
the GBP/USD rate agreed at the start of the swap. The company will fund its
payment of principal through the swap from accumulated sterling earnings from its
business and will use the dollar principal it receives in exchange to repay its dollar
borrowing.
This will be the case when the UK co. wants to swap its dollar loan into a sterling
loan, but needs dollars at the outset to pay for dollar imports or for any other
purpose. In this case, the UK co. would simply acquire the dollars from the spot
foreign exchange market. It would fund this spot purchase of dollars with the
sterling received through the swap in the initial exchange of principal amounts.
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Stages:
a. At the start of the swap, the UK co. buys dollars against sterling in the spot
market.
b. The dollar bought in the spot are exchanged through the swap for sterling, at
the same GBP/USD exchange rate at which the UK co. had to buy dollars against
sterling in the spot market; the sterling received through the swap is used to fund the
spot purchase of the dollars.
c. At the same time, the GBP/USD rate at which the principal amounts will be
exchanged at maturity is fixed at the spot rate at which the UK co. had to buy dollar
against sterling in the spot.
d. The interest rates for use in the swap are also agreed;
e. Over the life of the swap, the UK co. will pay a stream of sterling interest
through the swap and will receive a counter stream of dollar interest in exchange.
The dollar interest received will be used to service to the dollar borrowing; the
sterling interest paid through the swap will be funded from earnings.
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f. At maturity, the co. will pay a sterling principal amount through the swap and
receive a dollar principal amount in exchange. The exchange is made at the
GBP/USD rate agreed at the start of the swap. The co. will fund its payment of
principal through the swap from accumulated sterling earnings from its operations
and will use the dollar principal, it receives in exchange, to repay its dollar
borrowing.
Example:
A corporate has a loan of USD 10 million outstanding with remaining maturity of 2
years, interest on which is payable every six months linked to 6-month Libor + 150
basis points. This dollar loan can be effectively converted into a fixed rate rupee
loan through a currency swap.
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If the corporate wants to enter into a currency swap to convert his loan interest
payments and principal into INR, he can find a banker with whom he can exchange
the USD interest payments for INR interest payments and a notional amount of
principal at the end of the swap period. The banker quotes a rate of say 10.75% for a
USD/INR swap. The total cost for the corporate would now work out to 12.25%. If
the spot rate on the date of transaction is 44.65, the rupee liability gets fixed at Rs.
446.50 mio. At the end of the swap, the bank delivers USD 10 million to the
corporate for an exchange of INR 446.50 mio, which is used by the corporate to
repay his USD loan. The corporate is able to switch from foreign currency.