week6 - Derivatives and Risk Weeks 6 SWAP Introduction In...

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Derivatives and Risk Weeks 6 SWAP
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Introduction In the previous lecture, we discussed “Plain Vanilla” Interest Rate Swap . In today’s lecture, we will discuss basis swap, currency swap In the end, we will discuss equity Index Swap and Commodity Swap
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Two distinct types of SWAPs “Plain Vanilla” Interest Rate Swap: fixed/floating single currency interest rate swap Basis swap: floating/floating single currency interest rate swap. Different floating basis: LIBOR/other commercial paper rate The same floating basis but for different maturities: 3-month LIBOR/6-month LIBOR
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Example-Hedging with a sterling basis SWAP A major US bank has lent £10 million to one of its clients for 12 months. The loan is rolled over monthly, based on 1- month LIBOR +75bp. The US bank’s funding for this facility forms part of a much larger arrangement with one of the large inter-bank players, but the funding is based on 3-month LIBOR flat. The sterling desk manager wishes to even out the cash flow and the basis by entering into a basis swap.
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Example-Hedging with a sterling basis SWAP Risk: the same floating basis but for different maturities: receives 1-month LIBOR+75bp, pay 3- month LIBOR flat Strategy: pay 1s LIBOR and receive 3s LIBOR to set off against his money market funding. Quote from the SWAP bank for 1s against 3s, 12-month basis swap: pay 1-month LIBOR +0.45% against 3-month LIBOR flat
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Example-Hedging with a sterling basis SWAP £10m 1-month LIBOR+0.75% 3-month LIBOR US Bank Money market loan to client Money market funding
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Example-Hedging with a sterling basis SWAP 1-month LIBOR+0.45% 3-month LIBOR floating liability covered £10m 1-month LIBOR+0.75% 3-month LIBOR US Bank SWAP Bank Money market loan to client Money market funding
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Currency SWAP 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 Consists of three stages: 1. Initially, the parties exchange specific amounts of different currencies = exchange of the ‘principal’ 1. Parties continually exchange interest payments on the principal 2. Parties exchange principal back at maturity
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Currency Swaps Principal is exchanged based on an agreed rate of exchange Principal is the point of reference for calculating interest payments and re-exchange of the principal Interest rates can be fixed or floating against each other Swaps broaden borrowers’ access to  international lending markets Swaps are rather easy, quick and cheap the set  up – particularly compared to an international  loan
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An Example of a Currency Swap
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This note was uploaded on 04/21/2011 for the course BUSINESS AAF001-1 taught by Professor Dr.tony during the Spring '11 term at University of Bedfordshire.

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week6 - Derivatives and Risk Weeks 6 SWAP Introduction In...

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