1、11 The Swap Market (Chapter 14) McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-1 Essential Reading The Whole Chapter McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-2 Definitions lIn a swap, two counterparties a
2、gree to a contractual arrangement wherein they agree to exchange cash flows at periodic intervals. lThere are two types of interest rate swaps: nSingle currency interest rate swap u“Plain vanilla” fixed-for-floating swaps are often just called interest rate swaps. nCross-Currency interest rate swap
3、uThis is often called a currency swap; fixed for fixed rate debt service in two (or more) currencies. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-3 The Swap Bank lA swap bank is a generic term to describe a financial institution that facilitates swaps
4、between counterparties. lThe swap bank can serve as either a broker or a dealer. nAs a broker, the swap bank matches counterparties but does not assume any of the risks of the swap. nAs a dealer, the swap bank stands ready to accept either side of a currency swap, and then later lay off their risk,
5、or match it with a counterparty. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-4 An Example of an Interest Rate Swap lConsider this example of a “plain vanilla” interest rate swap. lBank A is a AAA-rated international bank located in the U.K. who wishes
6、to raise $10,000,000 to finance floating-rate Eurodollar loans. nBank A is considering issuing 5-year fixed-rate Eurodollar bonds at 10 percent. nIt would make more sense to for the bank to issue floating-rate notes at LIBOR to finance floating-rate Eurodollar loans. McGraw-Hill/Irwin Copyright 2001
7、 by The McGraw-Hill Companies, Inc. All rights reserved. 10-5 An Example of an Interest Rate Swap lFirm B is a BBB-rated U.S. company. It needs $10,000,000 to finance an investment with a five- year economic life. nFirm B is considering issuing 5-year fixed-rate Eurodollar bonds at 11.75 percent. nA
8、lternatively, firm B can raise the money by issuing 5- year FRNs at LIBOR + percent. nFirm B would prefer to borrow at a fixed rate. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-6 An Example of an Interest Rate Swap The borrowing opportunities of the tw
9、o firms are shown in the following table: COMPANY B BANK A DIFFERENTIAL Fixed rate 11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% QSD = 1.25% McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-7 10 3/8% LIBOR 1/8% An Example of an Interest Rate Swap Ban
10、k A Swap Bank The swap bank makes this offer to Bank A: You pay LIBOR 1/8 % per year on $10 million for 5 years and we will pay you 10 3/8% on $10 million for 5 years COMPANY B BANK A DIFFERENTIAL Fixed rate 11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% QSD = 1.25% McGraw-Hill/Irwin Copyright
11、 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-8 10 3/8% LIBOR 1/8% An Example of an Interest Rate Swap Bank A Swap Bank Heres whats in it for Bank A: They can borrow externally at 10% fixed and have a net borrowing position of -10 3/8 + 10 + (LIBOR 1/8) = LIBOR % which is % better
12、 than they can borrow floating without a swap. COMPANY B BANK A DIFFERENTIAL Fixed rate 11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% QSD = 1.25% 10% % of $10,000,000 = $50,000. Thats quite a cost savings per year for 5 years. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc
13、. All rights reserved. 10-9 LIBOR % 10 % An Example of an Interest Rate Swap Swap Bank Company B The swap bank makes this offer to company B: You pay us 10 % per year on $10 million for 5 years and we will pay you LIBOR % per year on $10 million for 5 years. COMPANY B BANK A DIFFERENTIAL Fixed rate
14、11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% QSD = 1.25% McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-10 LIBOR % 10 % An Example of an Interest Rate Swap Swap Bank Company B COMPANY B BANK A DIFFERENTIAL Fixed rate 11.75% 10% 1.75% Floating rate
15、 LIBOR + .5% LIBOR .5% QSD = 1.25% They can borrow externally at LIBOR + % and have a net borrowing position of 10 + (LIBOR + ) - (LIBOR - ) = 11.25% which is % better than they can borrow floating without a swap. LIBOR + % Heres whats in it for B: % of $10,000,000 = $50,000 thats quite a cost savin
16、gs per year for 5 years. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-11 LIBOR + % 10 3/8 % LIBOR 1/8% LIBOR % 10 % B saves % An Example of an Interest Rate Swap Bank A Swap Bank Company B A saves % The swap bank makes money too. COMPANY B BANK A DIFFER
17、ENTIAL Fixed rate 11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% QSD = 1.25% 10% % of $10 million = $25,000 per year for 5 years. LIBOR 1/8 LIBOR = 1/8 10 - 10 3/8 = 1/8 McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-12 LIBOR + % 10 3/8 % LIBOR 1/8%
18、 LIBOR % 10 % B saves % An Example of an Interest Rate Swap Bank A Swap Bank Company B A saves % The swap bank makes % COMPANY B BANK A DIFFERENTIAL Fixed rate 11.75% 10% 1.75% Floating rate LIBOR + .5% LIBOR .5% QSD = 1.25% 10% Note that the total savings + + = 1.25 % = QSD McGraw-Hill/Irwin Copyri
19、ght 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-13 The QSD lThe Quality Spread Differential represents the potential gains from the swap that can be shared between the counterparties and the swap bank. lThere is no reason to presume that the gains will be shared equally. lIn the
20、above example, company B is less credit- worthy than bank A, so they probably would have gotten less of the QSD, in order to compensate the swap bank for the default risk. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-14 An Example of a Currency Swap lSu
21、ppose a U.S. MNC wants to finance a 10,000,000 expansion of a British plant. lThey could borrow dollars in the U.S. where they are well known and exchange for dollars for pounds. nThis will give them exchange rate risk: financing a sterling project with dollars. lThey could borrow pounds in the inte
22、rnational bond market, but pay a lot since they are not as well known abroad. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-15 An Example of a Currency Swap lIf they can find a British MNC with a mirror- image financing need they may both benefit from a
23、swap. lIf the exchange rate is S0($/) = $1.60/, the U.S. firm needs to find a British firm wanting to finance dollar borrowing in the amount of $16,000,000. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-16 An Example of a Currency Swap Consider two firms
24、 A and B: firm A is a U.S.based multinational and firm B is a U.K.based multinational. Both firms wish to finance a project in each others country of the same size. Their borrowing opportunities are given in the table below. $ Company A 8.0% 11.6% Company B 10.0% 12.0% McGraw-Hill/Irwin Copyright 20
25、01 by The McGraw-Hill Companies, Inc. All rights reserved. 10-17 An Example of a Currency Swap Company A Swap Bank $8% 12% $8% 11% 12% $9.4% $ Company A 8.0% 11.6% Company B 10.0% 12.0% Company B McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-18 An Exampl
26、e of a Currency Swap Company A Swap Bank $8% 12% $8% 11% 12% $9.4% $ Company A 8.0% 11.6% Company B 10.0% 12.0% Company B As net position is to borrow at 11% A saves .6% McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-19 An Example of a Currency Swap Compa
27、ny A Swap Bank $8% 12% $8% 11% 12% $9.4% $ Company A 8.0% 11.6% Company B 10.0% 12.0% Company B Bs net position is to borrow at $9.4% B saves $.6% McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-20 An Example of a Currency Swap Company A Swap Bank $8% 12%
28、$8% 11% 12% $9.4% $ Company A 8.0% 11.6% Company B 10.0% 12.0% Company B The swap bank makes money too: At S0($/) = $1.60/, that is a gain of $64,000 per year for 5 years. The swap bank faces exchange rate risk, but maybe they can lay it off in another swap. 1.4% of $16 million financed with 1% of 1
29、0 million per year for 5 years. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-21 A is the more credit-worthy of the two firms. Comparative Advantage as the Basis for Swaps $ Company A 8.0% 11.6% Company B 10.0% 12.0% A has a comparative advantage in borr
30、owing in dollars. B has a comparative advantage in borrowing in pounds. A pays 2% less to borrow in dollars than B A pays .4% less to borrow in pounds than B: McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-22 B has a comparative advantage in borrowing in
31、. Comparative Advantage as the Basis for Swaps $ Company A 8.0% 11.6% Company B 10.0% 12.0% B pays 2% more to borrow in dollars than A B pays only .4% more to borrow in pounds than A: McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-23 A has a comparative a
32、dvantage in borrowing in dollars. B has a comparative advantage in borrowing in pounds. If they borrow according to their comparative advantage and then swap, there will be gains for both parties. Comparative Advantage as the Basis for Swaps McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Compan
33、ies, Inc. All rights reserved. 10-24 Swap Market Quotations lSwap banks will tailor the terms of interest rate and currency swaps to customers needs lThey also make a market in “plain vanilla” swaps and provide quotes for these. Since the swap banks are dealers for these swaps, there is a bid-ask sp
34、read. lFor example, 6.60 6.85 means the swap bank will pay fixed-rate DM payments at 6.60% against receiving dollar LIBOR or it will receive fixed-rate DM payments at 6.85% against receiving dollar LIBOR. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-25
35、Variations of Basic Currency and Interest Rate Swaps lCurrency Swaps nfixed for fixed nfixed for floating nfloating for floating namortizing lInterest Rate Swaps nzero-for floating nfloating for floating lFor a swap to be possible, a QSD must exist. Beyond that, creativity is the only limit. McGraw-
36、Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-26 Risks of Interest Rate and Currency Swaps lInterest Rate Risk nInterest rates might move against the swap bank after it has only gotten half of a swap on the books, or if it has an unhedged position. lBasis Risk
37、nIf the floating rates of the two counterparties are not pegged to the same index. lExchange rate Risk nIn the example of a currency swap given earlier, the swap bank would be worse off if the pound appreciated. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
38、 10-27 Risks of Interest Rate and Currency Swaps (continued) lCredit Risk nThis is the major risk faced by a swap dealerthe risk that a counter party will default on its end of the swap. lMismatch Risk nIts hard to find a counterparty that wants to borrow the right amount of money for the right amou
39、nt of time. lSovereign Risk nThe risk that a country will impose exchange rate restrictions that will interfere with performance on the swap. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-28 Pricing a Swap lA swap is a derivative security so it can be pr
40、iced in terms of the underlying assets: lHow to: nPlain vanilla fixed for floating swap gets valued just like a bond. nCurrency swap gets valued just like a nest of currency futures. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-29 Swap Market Efficiency
41、 lSwaps offer market completeness and that has accounted for their existence and growth. lSwaps assist in tailoring financing to the type desired by a particular borrower. Since not all types of debt instruments are available to all types of borrowers, both counterparties can benefit (as well as the
42、 swap dealer) through financing that is more suitable for their asset maturity structures. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-30 Alpha and Beta companies can borrow for a five-year term at the following rates: Moodys credit rating Alpha Beta F
43、ixed-rate borrowing cost 10.5% 12% Floating-rate borrowing cost Libor Libor+1% 1.Calcate the QSD. 2.Develop an interest rate swap in which both Alpha and Beta have an equal cost savings in their borrowing costs. Assume Alpha desires floating-rate debt and Beta desires fixed-rate debt. No Swap bank is involved in this transaction. McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 10-31 Readings lChapter 14
