Tài chính doanh nghiệp - Chapter 20: Interest rate swaps and currency swaps

Chapter 20Interest Rate Swaps and Currency swapsWebsites:  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonLearning ObjectivesUnderstand how interest rate and currency swaps operateOutline the various risks associated with swapsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation20.1 Introduction20.2 Interest Rate Swaps20.3 Currency Swaps20.4 Credit and Settlements Risks Associated with Swaps20.5 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.1 IntroductionTurnover in the Australian swap market in 2000/01 was AUD1.47 trillionSwaps may be used to hedge interest risk and exchange rate riskSwaps also enable investors and borrowers to obtain a lower cost of funds or a higher yieldCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation20.1 Introduction20.2 Interest Rate Swaps20.3 Currency Swaps20.4 Credit and Settlements Risks Associated with Swaps20.5 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate SwapsOrganised between borrowing partiesThe two parties swap their interest payment obligationsNo transfer of the principal amountBoth parties benefit from the swapExample: Table 20.1 outlines the current cost of funds for two borrowersFirm A has a credit advantage in both marketsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)StrategyFirm A borrows in fixed market, where it has comparative advantage (i.e. 12%)Firm B borrows in other market (i.e. floating) at BBSW + 1.70%.One possible swap arrangementB pays A a fixed rate of 13.60%A pays B a floating rate of BBSW + 1.70%Figure 20.1 illustrates the flow of funds and benefits of this interest rate swapCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)The majority of swaps require the involvement of an intermediary e.g. merchant bank, that often seeks an offsetting ‘matched swap’ i.e. It enters into opposite swap transactions to offset its net swap exposure, making a profit through a spread between the ratesFigures 20.2 and 20.3 in the textbook illustrate an intermediated interest rate swapCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)Rationale for the existence of interest rate swapsComparative advantageFor a comparative advantage to exist, the advantage in the fixed market must be different from that in the floating market (i.e. different risk premium)Why does this occur?Segmentation between floating and fixed debt markets (i.e. some types of institutions lend more heavily in floating markets while others lend more heavily in fixed markets)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)Rationale for the existence of interest rate swaps (cont.)Comparative advantage and efficient marketsDespite exploitation of arbitrage opportunities that have reduced the possibility of profitable swap arbitrage arrangements, the interest rate swap market continues to grow for other reasonsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)Other explanations for the growth of the swap marketParticipants developed and used existing products that previously were not the subject of swaps e.g. zero coupon bond swaps, dual-currency and multi-currency bond swapsChange in reasons for the use of swapsManaging or hedging existing interest rate and exchange rate exposuresCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)Hedging existing interest rate exposuresExample: a firm has an existing floating-rate loan and is concerned floating rates will riseStrategy: a firm is able to synthesise (create) a fixed cost loan byPaying a fixed rate to the swap counterpartyReceiving a floating payment from counterpartyEffect: if floating rate rises, firm’s payments to floating rate lenders increases, but are matched by increase in receipts from swap counterparty, and payment to counterparty remains fixedCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)Hedging existing interest rate exposures (cont.)Example: a firm has an existing fixed-rate liability and is concerned floating rates will fallStrategy: a firm is able to synthesise (create) a floating-rate cost of funds byPaying a floating rate to the swap counterpartyReceiving a fixed rate payment from counterpartyEffect: fixed rate payment received from counterparty is used to pay fixed-rate lenders, leaving the firm to make only a net floating-rate paymentCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)Hedging existing interest rate exposures (cont.)Example: a firm is locked into a fixed-rate debt (15%) above current interest rates charged on fixed-rate funds (13%) Strategy: a firm refinances at current lower fixed costs (see Figure 20.5)Pays floating-rate payments at BBSW (assume 12%)Receives fixed rate payments at 13%Effect: cost savings, if any, equivalent to gap between lower BBSW and higher fixed swap at 13%Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.2 Interest Rate Swaps (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation20.1 Introduction20.2 Interest Rate Swaps20.3 Currency Swaps20.4 Credit and Settlements Risks Associated with Swaps20.5 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.3 Currency SwapsTwo parties exchange debt denominated in different currenciesInterest payments are exchangedPrincipals exchanged at beginning of agreement and then re-exchanged at conclusion of agreementCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.3 Currency Swaps (cont.)ExampleTable 20.3 indicates there is a cost-of-funds benefit from the swap agreement of 0.25% p.a.Assuming X prefers USD and Y prefers AUDStrategyX borrows AUD20 million and transmits it to YY borrows USD15.2 million and transmit it to XExchange rate is AUD/USD0.7600X and Y agree on the interest payment swap ratesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.3 Currency Swaps (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.3 Currency Swaps (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.3 Currency Swaps (cont.)Example (cont.)X and Y interest payment swap ratesX pays 11.75% in USD to YY pays 9.875% in AUD to XBoth secure a cost of funds at 0.125% lower than if they had borrowed their preferred currency in their own rightCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.3 Currency Swaps (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.3 Currency Swaps (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.3 Currency Swaps (cont.)Example (cont.)X and Y re-exchange funds at maturity of swapX transmits USD15.2 million to YY transmits AUD20 million to XAt original exchange rate of AUD/USD0.7600EffectWhile FX risk is eliminated, both X and Y will need to purchase the relevant interest and principal amounts at the current exchange rate when dueCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.3 Currency Swaps (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.3 Currency Swaps (cont.)Rationale for the existence of currency swapsObtaining lower cost of fundsBorrowers may obtain better terms by borrowing in different markets including those denominated in foreign currencies; thus, creating the need for currency swapsHedging FX riskTwo companies can follow their comparative advantage in the debt markets and enter a currency swapCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.3 Currency Swaps (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation20.1 Introduction20.2 Interest Rate Swaps20.3 Currency Swaps20.4 Credit and Settlements Risks Associated with Swaps20.5 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.4 Credit and Settlements Risks Associated with SwapsCredit riskMost swaps are through an intermediaryIntermediary is at risk if one of the two counter-parties defaultsIntermediary is exposed to interest rate risk (i.e. uncertainty associated with fixed and floating markets)Exposure of intermediary limited to the difference between what a firm would have paid to, and received from, the intermediaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.4 Credit and Settlements Risks Associated with Swaps (cont.)Settlement riskThe risk that due to timing differences, one party to a transaction will not settle while the other party does settleSignificant time zone differentials can create this timing differenceCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation20.1 Introduction20.2 Interest Rate Swaps20.3 Currency Swaps20.4 Credit and Settlements Risks Associated with Swaps20.5 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson20.5 SummarySwaps facilitate the exchange of specified cash flowsInterest rate swaps are used to Reduce the cost of borrowingManage existing interest rate exposuresCurrency swaps are used when an interest rate swap involves borrowing in different currenciesAllow management of interest rate and FX risk exposureCurrency swaps differ from interest rate swaps in that the principal amounts raised by the two borrowers are are swapped at the commencement and re-exchanged at the end of the agreementCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson