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SWAPS

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Introduction To Swaps
It is an exchange contract between

two parties for two instruments of different yields, interest rates & currencies for the same amount.
A swap is equivalent to a portfolio, or

strip, of forward contracts--each with a4/23/12 different maturity date, and each

Mechanics of Swaps
Swap agreement is an exchange of cash flows

based upon a fixed and floating rate.


The agreement consists of one party paying a

fixed interest rate on a notional principal amount in exchange for the other party paying a floating rate on the same notional principal amount for a set period of time.
In this case the currency of the agreement is the

same for both parties. 4/23/12

Pricing of Swaps

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Advantages of Swaps
A Swap is flexible. It allows you to tailor the

Principal, payment frequency and maturity to suit your financing arrangement.


A Swap allows you to manage interest rate risk

without affecting the financing arrangement.


There is no upfront premium. They allow active currency exposure management

- i.e. hedging translation risk.


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Disadvantages of Swaps
You effectively lock in a fixed interest rate. This

means you cannot participate in favourable interest rate movements.


Early termination may incur a breakage cost

subject to market movements (see Early termination section).


It is subject to default risk or high credit risk.
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Types of Swaps
There are two types of swaps:
1. Interest rate swap an exchange of fixed-

rate interest payments for floating-rate interest payments.


2. Currency swap an exchange of interest

payments in one currency for interest payments in another currency


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Interest Rate Swaps


Party A agrees to pay a fixed payment and receive

a floating payment, from counter-party B.


Party A is the fixed rate payer-floating rate receiver

(the pay-fixed party).


Party B is the fixed rate receiver-floating rate payer

(the receive-fixed party).


Typically, there is no initial exchange of principal

(i.e., no cash flow at the initiation of the swap).


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Counterparty A is called the fixed rate payer or

swap buyer
Counterparty B is called the floating rate payer or

swap seller
Counterpa rty A

Fixed rate payments

Counterpa rty B
Floating rate payments

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Example On Interest Rate Swap

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Interest Rate Swaps: Common Uses rate swaps to Corporations employ interest
dynamically change their financing structure from floating rate exposure to fixed, and vice versa.
If interest rates are projected to rise, swaps

provide a low cost method to lock in current rates.


If interest rates are projected to fall, swaps can

allow corporations to take advantage of the lower financing costs.


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Interest Rate Swaps: Common Uses


Swaps can also more precisely match financing

risks with operational risks.


Swaps can be used to lengthen or shorten the

average maturity of a portfolio or liability structure.

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Currency Swaps
A currency swap is an agreement between two

parties to exchange a series of payments at specific dates in which one series of payments is in one currency and the other is in another currency.
Payments are based on the interest rates in two

countries.
Interest payments are calculated based on a fixed

amount of notional principal, usually paid in the final payment. 4/23/12

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

It is the interest rates that are fixed or floating.


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Example On Currency Swap

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Uses Of Currency Swap


To Hedge Against an increase/decrease in the Price

of a Foreign Currency.
To convert a liability in one currency into a liability

in another currency.
To convert an investment (asset) in one currency to

an investment in another currency.


To exploit their comparative advantages regarding

borrowing in different countries.


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THANK YOU

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