PRESENTATION ON SWAP

Presented By: Anjali Dwivedi Aparna Deepika yadav Garima Jain Pavitra Panwar Poonam Upadhyay Poonam kajal Seema Dhankar 1

INTRODUCTION TO SWAPS
A swap is an agreement between two parties to exchange (swap) payments at certain dates in the future.
As payments to B

Counterparty A

Counterparty B

Bs payments to A
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DEFINITION

A Swap is defined as a financial transaction in which two counterparties agree to exchange streams of payments, or cash flows, over time on the basis agreed at the inception of the agreement. Thus a Swap is like a series of forward contracts. Swap is nothing but exchange of liabilities between two parties.

DESCRIPTION

The payments can be : Different currencies (currency swap) Different interest payments (coupon swap) Payment dates are fixed at settlement and extend until a fixed expiration date.

ADVANTAGES

Swap is an instrument used for the exchange of stream of cash flows to reduce risk. The advantages of swaps are as follows:

1) Swap is generally cheaper. There is no upfront premium and it reduces transactions costs.
2) Swap can be used to hedge risk, and long time period hedge is possible. 3) It provides flexible and maintains informational advantages.
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4) It has longer term than futures or options. Swaps will
run for years, whereas forwards and futures are for the relatively short term. 5) Using swaps can give companies a better match between their liabilities and revenues.

DISADVANTAGES

The disadvantages of swaps are:

1) Early termination of swap before maturity may incur a breakage cost. 2) Lack of liquidity. 3) It is subject to default risk

CURRENCY SWAPS

A currency swap entails an exchange of payments in different currencies. A currency swap is equivalent to borrowing in one currency and lending in another. They involve exchange of cash flows in two currencies. The exchange rate generally used is the ruling spot rate. It is also used to raise funds in the market (currency, interest rate, etc.) in which it has a comparative advantage and use currency and / or interest rate swaps to achieve the desired liability portfolio, at a lower cost than otherwise. 8

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It involves the following:

Exchange the equivalent amount of different currencies. Exchange periodic interest payments during the life of the swap. Re exchange of principal sum at predetermined rate on the maturity of the swap. These amounts will be re exchanged at predetermined rates at the maturity of the currency swap. The parties will service the loans in the respective currencies.

ELEMENTS OF CURRENCY SWAP

There are several important element in a currency swap that must be agreed between the two parties:

The period of the agreement. The two currencies involved. The principal amount of each currency, and the exchange rate. The basis for exchange of interest rate payments. Whether or not there will be an exchange of principal at the near-value date.
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BENEFITS OF CURRENCY SWAP

Help portfolio managers regulate their exposure to interest rates. Speculators can benefit from a favorable change in interest rates. Reduce uncertainty associated with future cash flows as it enables companies to modify their debt conditions.

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Reduce costs and risks associated with currency exchange. Companies having fixed rate liabilities can capitalize on floating-rate swaps and vise versa, based on the prevailing economic scenario.

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LIMITATIONS OF CURRENCY SWAP

The drawbacks of currency swaps are: Exposed to credit risk as either one or both the parties could default on interest and principal payments. Vulnerable to the central governments intervention in the exchange markets. This happens when the government of a country acquires huge foreign debts to temporarily support a declining currency. This leads to a huge downturn in the value of the domestic currency.
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TYPES OF CURRENCY SWAP

There are four types of basic currency swap: fixed for fixed. fixed for floating. floating for fixed. floating for floating.

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EXAMPLES OF CURRENCY SWAP

Example 1

Company A is doing business in USA, and it has issued a $20 million dollar-denominated bond to investors in the US. Company B is doing business in Europe, and It has issued a bond of $ 15 Million Euros. The two companies can enter into an agreement to exchange the principal and interest of the bonds. The $15 million Euro-denominated bond will be the obligation of company A, and company B will be obligated to the $20 million bond.
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Example 2

Suppose one USA company wants to start his factory in India. For this it gets $10 billion dollar in the form of loan from USA market and Exchanges this amount from India company B. Now company A has Indian currency for doing business in India and company B which is Indian company has USA currency and it can get Forex earning. It means that both are benefited with single deal of currency swap.
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Example 3

An agreement to pay 1% on a Japanese Yen principal of 1,040,000,000 and receive 5% on a US dollar principal of $10,000,000 every year for 3 years.

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CURRENCY SWAP
ROI in $

Principle in $

Principle in EURO

ROI in EURO

On maturity of contract Party A Party B

Swap of ROI of different currency Plus Swap of currency at original spot rate
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VALUATION OF CURRENCY SWAP

Currency swaps can be valued either as the difference between 2 bonds or as a portfolio of forward contracts. Fixed by fixed currency swap is valued as the difference between the two fixed rate bonds, valued in a common currency. The Principal of bonds such that they have the same value at time zero.
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Fixed by floating currency swap is valued as the difference between a fixed and floating bond, valued in a common currency. The Principal of bonds such that they have the same value at time zero.

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